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Budgeting & Banking

Peer to peer lending 2022

Keen to know more about peer to peer (P2P) lending? Here's all the key info you need, including the risks of P2P loans.

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Peer to peer lending has its perks (not least the good interest rates on investments) but it's not without risk.

To clarify some of the confusion around P2P lending, we've put together the key facts about how it works, the risks involved and info about peer to peer firms.

So, if you are interested in finding out more about peer to peer lending, either in terms of borrowing or investing money, read on for the info you need to get started.

The economic uncertainty caused by the coronavirus outbreak and Brexit could increase the risks of P2P lending. Be careful before investing or borrowing money, and don't invest anything you can't afford to lose.

What is peer to peer lending?

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As the name suggests, peer to peer loans are lent by people to other individuals or businesses (i.e. from one peer to another).

The money is lent via lending companies, which manage the loan distribution and repayment process.

Borrowing P2P loans can seem tempting at first glance. The lending platforms generally offer a wide range of loan amounts with competitive rates. While they can help in some situations, we'd urge you to consider your other, lower-risk options first – particularly the government's Student Loan.

Also, lending money through peer to peer firms can see you potentially earn a good amount of interest on the money you invest. When done carefully, there's the potential for you to make more money than you would if you used a savings account. But, bigger interest rates come with bigger risks.

Make sure you know the risks of peer to peer lending before investing or borrowing money.

Risks of peer to peer lending

Whether borrowing or lending money through P2P lending, there are risks involved. Here are the key things to bear in mind:

Borrowing money through peer to peer loan sites

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As is the case when taking out any type of loan, it's important to think things through carefully and make sure it's really the best option for you.

In particular, the main risks involved in borrowing a peer to peer loan are:

  1. Inflexible repayment amounts – It's unlikely you'll be able to change your monthly repayment amounts so you'll need to be confident you can afford each repayment before making any commitments.
  2. Hard credit check – Taking out a loan requires a hard credit check which leaves a mark on your credit score report. Having too many hard credit checks (particularly over a short period of time) affects your credit score and can harm your chances of getting credit in future.
  3. Missed repayments – If you fall behind on repayments, your credit score will take a hit and there's a chance you could have the funds reclaimed by debt collectors.

If you have any doubt that you might not be able to make each repayment in full and on time, we'd urge you not to take out the loan.

As well as this, think about whether taking out a P2P loan would lead you to have too many hard credit checks within a short period. If you think that it might, try to find a different source of funding that won't impact your credit score.

It's worth noting that you'll face similar risks with most loans from credit lenders. However, you won't find these risks with the government's Maintenance Loan, which you'll stop repaying anytime your income falls below a certain amount. Plus, you won't undergo a hard credit check when applying for a Student Loan.

Even if you're confident you can manage the risks, we'd still encourage you to look into your alternative funding options before taking out a peer to peer loan – you might be surprised by how much funding is available to you elsewhere for no or minimal risk.

Lending money through peer to peer loan platforms

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Lending money in the form of peer to peer loans can be a good way to make money as, if it pays off, you'll earn your cash back plus interest. But remember that investors face more risks than borrowers.

Here are the main risks involved in lending money as a peer to peer loan:

  1. Losing money – Any investment you make through P2P lending relies on other people paying back the loans for you to make money, or even get all of your money back. If you do invest, look for a loan firm that tries to repay you if borrowers miss payments.
  2. No FSCS protection – You won't be covered by the Financial Services Compensation Scheme (FSCS) as you would usually with savings accounts. FSCS would cover you for up to £85,000 if it applied here, but as it doesn't, your P2P investment wouldn't have the same level of protection as your savings.
  3. Uncertain economy – P2P lending is a relatively new industry, so loan companies could struggle to survive in the current climate (affected by the coronavirus pandemic and Brexit). It may also be harder for some borrowers to keep up with repayments. In 2021, RateSetter, Zopa and Funding Circle (three of the leading P2P firms) stopped accepting new investors, highlighting that it could be challenging for the industry to continue in the long term.
  4. Slow return on investment – There's a chance that the money you invest through P2P loan firms won't be lent out straight away as there can be a wait before your money is matched to borrowers. Because of this, it's not guaranteed that you will start earning interest immediately.
  5. Difficult to withdraw investments early – We'd strongly advise against investing in P2P loans if there's a chance you'll need the money back early. Some lending platforms are more flexible than others, but you may be charged a fee to release the funds before repayments are due.

Like with any form of investment, it could be worth doing if you're confident you can manage the risks – but you should never invest more money than you can afford to lose.

Peer to peer lending sites

Because of the risks, we recommend using a more established P2P firm if you do decide to borrow or lend money this way. However, in 2021, Zopa, RateSetter and Funding Circle (which had been three of the leading peer to peer loan firms) stopped accepting new investors.

At the time of writing, some smaller firms are still accepting new investors such as Folk2Folk and CrowdProperty. Smaller P2P firms (or any P2P firms, for that matter) may be at risk of struggling with the economic climate. Plus, smaller firms may potentially have fewer measures in place to repay investors if borrowers are unable to keep up with the repayments.

If you are considering investing in peer to peer loans, please do thorough research, make sure you're aware of the risks and don't invest any money you couldn't afford to lose.

Do you need to pay tax on your investment income?

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You may have come across a peer to peer lending firm that gives you the chance to invest through an ISA – any interest you earn through an ISA is tax-free.

But, if you don't invest through an ISA, you will need to declare your interest for tax.

If your total income (including a salary and any interest you've earned) is below £12,570, you won't need to pay any tax at all because this falls below the Personal Allowance amount.

As well as the Personal Allowance, if you're earning below £17,570, the interest you earn is covered by a starting rate for savers of up to £5,000. This means that if you earn between £12,500 and £17,500, you still don't need to pay tax on the interest from your investments.

Better yet, the first £1,000 of interest you earn is tax-free.

So, it's not until you're earning above £18,500 (salary and interest combined) that you'll start paying tax on the interest you've earned.

Still not sure if you need to pay tax? See our guide on the important rules of tax.

Claiming tax relief on unpaid loans

If you're earning enough to be paying tax on your interest, you can claim tax relief on unpaid peer to peer loans. This applies when it's clear a loan isn't going to be repaid in full (not when a repayment is simply late).

For the tax relief, you can set the loss against other interest you've earned from peer to peer loans before your total income is taxed.

You can find more info on this here.

Alternatives to peer to peer loans

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For lower-risk ways to get by at university, we recommend trying these alternative funding sources before taking out a P2P loan or investing in one:

  • Student Loan – While Maintenance Loans are by no means perfect (especially as they're calculated based on household income), they have very reasonable repayment terms and we would always suggest taking out a government loan before borrowing money from elsewhere.
  • Part-time job – If you have time around your studies, a part-time job is a great way to earn money at university (and it has the added bonus of boosting your CV!).
  • Scholarships, grants and bursaries – You could be eligible for a scholarship, grant or bursary which is effectively free money as you wouldn't need to pay it back.
  • Family – While not everyone's family can or will lend them money, it's worth at least asking if yours will, if you need the money. This would involve paying no or minimal interest and would (hopefully!) have flexible repayment terms. We also have a guide that covers some ways you can make money from helping your parents.
  • Savings account – Although savings accounts generally have much lower interest rates than P2P loans, they involve much less risk.
  • 0% interest overdraft – One major perk of student bank accounts is getting an overdraft with 0% interest. It can really help you get by between Student Loan instalments without having to worry about interest and you'll likely not need to pay it all off until the year after you graduate.
  • Hardship funds – If you find yourself struggling for money as a student, find out if you could receive a hardship fund from your university. The uni will have some money set aside to help students in financial difficulty, and it could help you avoid the risks associated with taking out a P2P loan.

Investing in peer to peer loans is one way to earn a passive income, but we happen to know of some lower-risk ways to get free money...

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