Savers hunting for decent interest rates on their cash may be tempted to lend their money to other individuals or small businesses through “peer-to-peer” (P2P) websites such as Zopa – as these can offer returns of 8 per cent or more.
But experts warn that lending cash in this way involves extra risks compared with conventional savings accounts, as capital is not guaranteed, returns can be hit by bad debts and there is no protection under the Financial Services Compensation Scheme (FSCS).
Increasing numbers of savers have been drawn to P2P lending, say the sites, because banks and building societies are currently offering savers such low rates – the average instant access account now pays under 1 per cent.
“By far, the biggest attraction has been the higher returns offered compared with savings rates,” says Zopa, the largest of these online marketplaces, which has just started television advertising to attract more borrowers. “We have seen a big growth in lenders’ funds and have millions of pounds available to lend out.”
Zopa has 25,000 active lenders and 16,000 borrowers, and arranges millions of pounds a month in new loans.
Four other sites have also launched recently, some quoting rates of more than 20 per cent for lending to higher-risk borrowers or, in the case of Funding Circle, allowing individuals to lend to UK small companies for estimated returns of 6 to 9 per cent.
P2P users lend out a few thousand pounds on average although they are encouraged to spread their money across a range of borrowers to reduce risk, and can offer amounts as low as £10.
Zopa says that rates currently available to individuals making a typical three-year loan through its site are over 7 per cent, with higher rates for lending to borrowers who are deemed less creditworthy or for longer terms.
Its quoted rates include a 1 per cent charge that Zopa levies on lenders, but does not include possible bad debts. The site expects these to average 1.5 per cent, taking the typical return down to about 6 per cent.
In practice, though, Zopa says bad debts have averaged below 1 per cent and, even in the latest recession, remained relatively low compared with other lenders.
According to Giles Andrews, Zopa chief executive: “Returns have been similar to long-run equity returns, with more predictability.”
However, Justin Modray of CandidMoney.com, a consumer website, says: “Returns have certainly been better than on savings accounts, but the question is whether the extra few per cent is worth the extra risk.”
In a recent Which? mystery shopping test, the consumer group was offered rates ranging from 6.8 per cent at Zopa to as low as 3.2 per cent from RateSetter for lending minimum amounts of £10 to £30.
Which? also warned: “P2P lending should not be considered an option for your nest egg, but for money you want to speculate with and can afford to lose if something goes wrong.”
Modray says that while P2P marketing often suggests that such lending is an alternative to cash deposits, savers should compare it to corporate bond-style investing in terms of risk.
He points out that P2P services “fulfil a socially useful purpose” in bringing together lenders and borrowers at a time of low savings rates and restricted bank lending.
But if unemployment were to rise strongly, there could be much greater default levels and losses for lenders.
Zopa says it parcels out loans of more than £500 to at least 50 different borrowers, so that an individual default does not slash overall returns.
Sites also credit check and risk-rate potential borrowers on behalf of lenders, as well as chasing up bad debts, while RateSetter holds a “provision fund” to maintain repayments in the event of a default.
As borrowers generally repay on a monthly basis, lenders also see at least some of their money returned through the term, and in some cases can exit their loans early – though generally for a charge.
However, Modray suggests that P2P lenders should be particularly wary of lending to small businesses.
“Banks are not lending much because they’re worried – that’s a reason to be ultra cautious,” he says.