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Thursday, 28 January 2016

UK Peer to Peer Lending – Is it really ‘Too Good to be True?’

Many self-proclaimed financial experts say Peer to Peer lending (PtPL) is flawed and full of risk.  Most of them are directly or indirectly employed by big banks or brokers and have an interest in maintaining the financial status quo.  But then this is no different to the doom-mongers who have been predicting a stock market crash every month since the great depression!

Here are some classic arguments:

     No Government Protection

The UK Government underwrites approved bank and building society SAVINGS via the Financial Services Compensation Scheme (FSCS).  This scheme clearly doesn’t extend to anything with risk whether stocks, shares, funds or peer to peer loans.

However, this doesn’t mean that government doesn’t like PtPL.  The Government regularly invests 10% in loans to small/medium UK businesses through platforms such as Funding Circle.  

The UK Government is also encouraging PtPL via it’s new third ISA, known as the Innovative Finance ISA.  There may be no government protection for PtPL but equally there has never been any state compensation for losses in any global stock market.

 Too Risky

Risk is relative.  Buying shares or funds is very risky.  I have a pharma fund that gained well over 10% in less than a year but where am I now? – a loss of around 10%! 

The risks in PtPL are much easier to quantify and you can also build a mixed portfolio to cover many of the risks.  So, for example, on each platform, you should spread your cash across a relatively large number of loans.  If the platform offers loans secured against a range of assets then mix the assets.  For example, with a platform like Money Thing you can spread the risk between several asset classes including fine art, railway memorabilia, land, property or super cars. 

In practice, while stocks and shares jump around in an almost totally unpredictable manner, PtP loans result in a fairly steady and predictable stream of interest. This makes PtPL an ideal regular income source.

     The Platform Might Fail

Do your own ‘due diligence’.  Check out the company, the backers and what other users think (Why not join the PtP Independent Forum?).  Examine the platform’s loan supply and their track record in terms of both defaults and recoveries.

 Too Many Defaults

Lower interest sites like ZOPA or Ratesetter (typically 5-6% over 5 years) have provision funds to cover defaults.  Other platforms such as Funding Circle (FC) have a projection for defaults that you can include in your own calculations. 

For example , the safest FC risk category is A+.  This typically pays around 8% interest.  FC charge a fee of 1% and estimate a 0.6% loss due to defaults.  The actual net projected interest in this example is therefore  6.4%.

Other sites, such as Saving Stream, Money Thing, Funding Secure and Assetz only offer secured loans against assets such as property.  This means that, provided the valuation is correct, you should eventually get all your money back, in the case of a default, once the asset is sold.  You can also check the platform track record in terms of defaults to estimate the risks.

A Final thought

 You don’t need to be a financial expert to do Peer to Peer Lending.  What you do need is some common sense and you should make sure that you never invest money you can’t afford to lose.  If I invest say £50,000 in PtP then I clearly need to make sure that I don’t put £25,000 on a single loan!  Ideally I should spread my investment across several platforms and make sure a good proportion of the total is invested at relatively low risk.

Yes Peer to Peer lending may, at first sight, seem too good to be true but my advice is to give it a try and see how it works out for you by taking out some trial small loans.  You might be pleasantly surprised.  

I would suggest PtPL is far less risky than the stock market and far more rewarding than a savings account, even without the government protection!

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