Peer-to-peer lending tempts hard-hit savers
Interest rates have been at a record low of 0.5% for more than four years and that has meant a paltry rate of return for many savers.
So instead of putting their money into a bank or building society, some have turned to an alternative way of investing their money, known as peer-to-peer lending.
Also called social lending, this allows savers to lend directly to individuals or businesses looking to borrow money. It often provides a better return than they would get with their bank, but there are greater risks involved and less protection for their investment.
At present, there are three big players in the market: Zopa, Funding Circle and RateSetter. These three companies have overseen about £458m of loans and many predict this figure will continue to rise.'Testing the water'
Nick Hallwood is a project manager from Surrey. He inherited some money when his aunt died last year. He joined Funding Circle and has invested in more than 200 companies in the past year.
"With a small amount of money I decided to dip my toe in the water. I was quite interested in lending to small businesses and helping to support them at a time when perhaps banks were not," he says
His other motivation to invest in a peer-to-peer lending scheme was discovering how little interest he would receive from High Street bank and building society savings accounts.
End Quote David Black Consumer Intelligence
You need to be aware that your funds are not covered by the Financial Services Compensation Scheme and also there is the potential of bad debts”
The rate of return on easy access accounts has fallen by an average of 68% over the past two years, according to financial information service Moneyfacts. At the start of this month, the average rate on an easy access savings account with no bonus was only 0.76%.
Mr Hallwood says he has seen a much better return than this. Over the past tax year he has worked out that he has earned 4.9% interest on his investment, despite facing a few problems with his investments.
"I have received some bad debt. Some companies won't always be able to pay back the loans that you have given," he says.
"But even with that bad debt, I've probably got twice the return than I would have if I had put my money in a one-year bond with a bank."Risks involved
Peer-to-peer lending is still dwarfed by traditional bank lending to small and medium-sized businesses, which in gross terms stands at about £3bn a month.
Unlike the more traditional forms of lending, there are some additional risks to be aware of with peer-to-peer lending. David Black, of the information firm Consumer Intelligence, points out that there is one major guarantee missing from these peer-to-peer lending schemes.
"You need to be aware that your funds are not covered by the Financial Services Compensation Scheme and also there is the potential of bad debts," he says.
This means that these schemes do not have the same protection as savers with UK-registered banks, building societies and credit unions. Under the FSCS, the first £85,000 of their funds per person per institution are protected if it goes bust.
Mr Black believes that the sector is trying to address this shortfall.
"Some of the schemes do have a safeguard provision fund to cover some of the bad debts. It is also worth bearing in mind that until next year they are not covered by the regulatory authorities," he said.'Phenomenal growth'
The peer-to-peer lending sector is growing fast. Christine Farnish, of the Peer 2 Peer Finance Association, believes there is still more growth to come.
"I think they are just scratching the surface of the potential market at the moment. They are growing at about 250% a year, which is pretty phenomenal," she says.
A recent study by innovation charity Nesta suggests the sector has the potential to account for £12.3bn of loans a year.
But Mr Black warns that this does not mean every scheme will be a success.
"There are a number of smaller players that have ceased training. So it is a competitive business and not all of them will make it," he says.
So, for those tempted to invest in a peer-to-peer lending scheme, how good an investor do you need to be?
The Nesta study concludes that the typical saver who put money into these schemes was "highly educated and relatively wealthy" but Mr Hallwood believes anyone can do it and it will not take up all their time.
"It is actually quite fun looking at these businesses and investing in them. If I look at the time I'm spending on this a week, it is probably an hour, perhaps two hours at most," he says.