Since its inception in 2005, the peer-to-peer (P2P) industry has grown exponentially.
For more than a decade, the industry has allowed investors willing to get more hands on with their investment far better rates than a savings account and more control over the nuts and bolts.
So, what are the differences between a P2P investment and traditional cash savings? Let’s take a look.
Potential for higher rates of return
When you shop around for a savings account, the first port of call is usually the rate of return. One of the major selling points of a P2P investment can be the potential for higher rates compared to savings accounts.
With typical P2P return rates between 5% and 10%+, the interest is often higher than the interest in savings accounts with banks.
In a savings with a bank, in the background the bank is pooling money from their savers and distributing it to borrowers at an agreed interest rate. The capital is gathered and paid back to the savers but not before the bank takes a cut to pay overheads such as staff, buildings and of course, profits.
With a P2P investment you lend your money directly to the borrower – cutting out the middleman.
The P2P platform gets paid by taking an amount of the interest paid by the borrower, not by cutting your interest rate as an investor.
As P2P platforms are online businesses, this also drastically cuts their overheads when compared to a traditional banking institution and these savings can then passed on to you in the form of greater returns.
However, there is an important difference between the two. P2P is technically an investment, not a cash savings and as such, is not covered by the Financial Services Compensation Scheme (FSCS), so your capital could be at risk, whereas in a traditional savings account you are protected up to the value of £75,000.
Greater control over your investment
Self-select P2P platforms allow for even more control over where your money goes. With a self-select P2P investment, you’ll be responsible for researching the borrower and dealing with loan proposals. This means that you’ll have more control over who you’re lending to than you would with a traditional bank, where your investment is pooled together with countless others and invested in people or businesses that the bank chooses.
That said, not all P2P platforms allow you to self-select borrowers.
In account-based P2P investments, you’ll place your money in the hands of the platform who will spread your investment across many different borrowers depending on the level of risk that you select, similar to a bank.
What about ISAs?
With the introduction of the Innovative Finance ISA (IFISA) this tax year a new milestone has been reached by the P2P industry. For the first time, you can have a tax-free ‘wrapper’ on your P2P investments - up to the normal £15,240 threshold – a significant recognition of the importance of alternative finance.
Just like Stocks and Shares ISAs and Cash ISAs, you can spread your allowance over the three types of ISA up to the maximum value of £15,240.
What are the downsides?
P2P platforms connect you, the investor, to the borrower without a bank acting as an intermediary and regulating performance across a loanbook in the billions of pounds. With a smaller amount on loan across a smaller number of lenders, this can mean that should a borrower default or miss a payment, your investment that could be at risk.
By way of combatting this, P2P platforms spread your investment across many borrowers and lend small portions of your investment to each one (depending on the platform you choose). This means that should a borrower default, your investment with that person or business should be minimised by the rest of your investments. Some platforms also offer Provision Funds and other security services which pay out if a borrower misses a payment or defaults on a loan as a different form of protection. These are discretionary and not all platforms provide them. To find out more about the way that P2P platforms try to safeguard your investment, read our guide.
As mentioned above, P2P investments are not treated in the same way as savings and as a result are not currently covered by the Financial Services Compensation Scheme (FSCS). The FSCS covers anyone who has invested in a savings account up to £75,000 (or £150,000 in a joint account) if the bank goes under in a financial crisis. As P2P investments are not covered, if the platform goes bust you could lose your investment so it may be worth holding a percentage of your funds in a cash savings too.
Is a P2P investment right for me?
That very much depends on you as an individual and how experienced you are with investing. If you’re after greater returns from your investment and relish at the chance to get more hands on with your money, P2P allows you to act as your own investment manager and potentially reap higher returns than with a traditional savings account.
Though riskier than cash savings, P2P is far less volatile than stocks and shares and usually has fixed rates of return, much like cash savings. If you’re a P2P investor without the knowledge required to invest in stocks, shares and funds or even the self-select style P2P platforms, account-based P2P may be the answer.
Our straightforward guide to peer to peer investing
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