Should you take a chance with P2P lending?

As traditional savings rates fall, many savers are tempted to take on a little extra risk with peer-to-peer (P2P) lending, says Ruth Jackson.

As traditional savings rates fall, many savers are tempted to take on a little extra risk with peer-to-peer (P2P) lending. With P2P, your savings are lent out to businesses and individuals. You then get your money repaid at the end of the loan, plus interest.

Because you are getting the interest rate people are prepared to pay in order to borrow, you get a much higher rate than is offered on savings accounts. For example, Zopa is currently offering annualised returns of up to 6.5%, RateSetter offers up to 5.5% over five years, and Funding Circle up to 7.1%.

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However, you are also taking on more risk. First, there's the risk that the borrowers don't pay you back. You can mitigate this by choosing a P2P lender such as Zopa or RateSetter who have provision funds in place to cover bad debts (although these funds are limited if they were exhausted by high levels of bad debts, users could still lose money). Second, P2P is not covered by the Financial Services Compensation Scheme. This means if the platform went bust, you could lose your savings.

The Financial Conduct Authority began regulating P2P firms back in 2014, but some in the industry are calling for stricter rules. The P2P Finance Association (P2PFA) has warned the industry is growing at a rapid rate and needs tougher regulation to make sure customers understand what they are investing in.

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"Investors need to be aware that peer-to-peer lending products in no way resemble the guarantees represented by a bank deposit," says P2PFA, whose director has labelled as "unhelpful" certain advertisements that suggest P2P is like a bank account with instant access.

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