In my Income & Expenses report in May I received some income from a Peer to Peer (P2P) lending company. Following the post, I had a few questions about what P2P lending is, how I had found it so far, and would I recommend it. So I thought it would be worthwhile writing a post on it.
I have two main aims in writing this post:
- I want to explain what Peer to Peer lending is for people that haven't heard of it or know little about it.
- I will let you know precisely what I've earned from doing it so far, and the associated charges. This is in line with my full disclosure on this Blog.
Peer to Peer Lending - What is it?
I came across P2P lending when I was searching for 'Passive Income Streams' online. There were companies like Funding Circle, Zopa, and Ratesetter that were offering over 6% Return on Investment (ROI). That peaked my interest, but was it too good to be true...
These companies allow investors (you and I) to put money into their accounts to lend out to borrowers or companies. Borrowers get slightly lower rates than banks, and lenders benefit from a better ROI as we're cutting out the big middle-man, Banks. A win-win for both parties!
They look like savings accounts, but they're not. You put money into an account and you get a return on investment at a set rate, which is is considerably higher than what banks offer. The main difference however is that there isn't a 'savings safety guarantee' like there is with an NISA or regular savings account. Every UK-regulated current/savings/NISA account in banks, building societies, and credit unions are covered by the government-backed Financial Services Compensation Scheme (FSCS). So, if you're bank were to collapse, you're covered up to an amount of £85,000 (currently, as of July 2014) per person, per financial institution.
I didn't like the sound of this. My money wasn't protected, and theoretically, I could lose some of it, if not all of it.... but I kept researching to find out more about it. I think the lack of protection within P2P lending is a big factor in people not trying P2P lending. I thought it was worth finding out a little more before I made my decision.
'Bad debts' and Tax
There is always a possibility that some money might be lost through 'bad debt' (where borrowers collapse and are unable to pay money back to lenders), but there are measures in place to minimise the risk to the investor. Borrowers are subject to credit checks and are subsequently rated according to risk so the Lenders can select the level of risk they're comfortable with. Also, it's worth mentioning that the P2P companies do all the chasing for you too (if you were to go down that route), so you don't have to resort to 'door knocking' with the 'Heavies'.
You can minimise the risk further by investing in multiple companies or borrowers (spreading the risk). For example, you could invest £1,000 into an account and lend £20 to 50 companies. So, if one company went bust, you wouldn't lose your whole investment, only 2% (max) of your investment would be affected.
The income you earn is subject to Income Tax like any other regular savings account. You'll be taxed as a basic rate tax payer (20%), higher rate (40%) or top rate (45%) off your earnings.
It's worth pointing out that you also have to pay tax on 'bad debts' from your earnings. I've invested with Funding Circle (FC), who lend to companies rather than individuals, and they have the highest ROI. With FC, if I'm given a 10% ROI, but after bad debt I only get 5% (the company went bust), I'll still get taxed (20% for me) on the 10% rather than the 5%. This backs up the strategy of only putting in small amounts to each company and spreading the risk out.
Peer to Peer Lending is now Regulated
As of 1 April 2014, P2P companies have been regulated by the Financial Conduct Authority. They have put some new rules in place for the P2P lending companies to adhere to, and if they don't they could face a large fine.
They have to clearly display all information on the person/company. They have to be honest about the level of risk involved and they need to have plans in place, just in case something goes wrong.
Now after reading all of that, some of you might be completely put off from using them. I have to be honest, I was sceptical myself. In January 2013, I had some leftover money for investing, and I wanted to give it a go. I was motivated to find alternative forms of passive investing, and I thought this 'could' be a future option for me. I could sit there and speculate or I could give it a go and see what happens. I decided on the latter!
Peer to Peer lending with - Funding Circle
There were a few companies to choose from, but I decided to go with Funding Circle. It's a bit like Dragons Den where people ask for a set amount of capital, they disclose their financial information, FC rate the level of risk associated with that company, and then you can place a 'bid'.
Let's say for an example a company needs £50,000 to invest in a new transport line. You can choose to supply a minimum of £20 or up to an unlimited amount.
Once you're comfortable with the amount you want to lend, you select the % return you want to receive. Brilliant right, "I'll have 10% return please"..... well, you can select 10% if you wish, but the loan will be given to the company based on the lowest total % suggested once the time for the loan request expires. Think of the opposite of Ebay, the lowest bid wins.
For a £50,000 loan - Let's say I bid £25,000 for a 10% return. Joe Bloggs puts down £25,000 for 9.8%, and Dave Brave puts down £25,000 for 9.7%. This company has £75,000 worth of investment put to him, but he can only take £50,000. As my yield is the highest, I'm eliminated from the bidding process, but I'm free to go back in and offer a better rate up until the time runs out. So, I decide to go in with £25,000 for 9.6%........ and so on and so on.
After the Loan is complete, you will have a range of people getting different returns, like in the example above I got 9.6% and Dave Brave got 9.7%.
Bidding made easy
Similarly to Ebay, you can use Funding Circle's tool 'Autobid'. This allows you to set parameters you're happy with based on Risk levels. Risk band A+ suggests the company are very sound and secure. The chances of anything bad happening are extremely low. The % return for these are a lot lower, and more in line with what Banks offers for fixed rates. You might want to set a top threshold at 6%, and a low threshold of 4%. The 'Autobid' feature will automatically bid for you within these parameters, if it falls below 4%, it will no longer bid on a company in A+ risk. For risk level B, you can select top end of lets say 8%, and a bottom threshold of 6%, you can even select that you don't want to bid anything for level C if you wish.
You can adjust the thresholds at anytime, and you can also turn the 'Autobid' off at anytime and resort back to self selection.
My Experience with Funding Circle and P2P lending
As I've already mentioned, I didn't know how this was going to turn out, so in January 2013 I decided to use £180 as an experiment. (This amount was initially £200, and it then went down to £180)
I wanted to spread the risk as much as possible, so I decided to only invest £20 in a single company, therefore I could have 9 x investments.
I started by reviewing each company separately, and attempting to select them on their own merits. After a few days of researching and analysing, it dawned on me that I was still taking a risk, and although I might be minimising it, there was no guarantee that the investment would be 100% safe. I found the analysing process was also very time consuming. After I had decided on which company I was happy to invest with, I still had to compete with other investors to get the best rate I could. This resulted in me bidding and succeeding and in some cases missing out. I found it quite frustrating to spend a lot of time analysing a company only to miss out on investing in them.
Once I had invested in a couple of companies using this format, I decided to try the Autobid tool to see if I could benefit from a better rate and save some time.
Funding Circle have a statistics tab where you can view what the lowest, highest and average % yield is given to each Risk Level across hundreds of loans. For Autobid, I decided to set my lowest threshold just above the 'average' mark and the highest threshold above the highest mark. For example, if the Risk Level B loan had the lowest rating at 5%, the average at 7%, and the highest at 9%. I would set the lowest marker at 7.5%, and the highest 10%.
This way I would at least get an above average ROI, and I could get a record achieving high return. This process was slow because a good chunk of loans would qualify below the % returns I was asking for, but it saved me personally a large amount of time to do other things. It also resulted in returns much better than I expected.
Out of the 9 investment loans I have, my lowest return is 8.6% (for an 'A level' risk), and my highest yield is 12.9% (for a 'C level' risk). My average gross yield across all 9 is 11.1%. These rates are before tax and fees.
From the £180 I initially put into the account, I've taken out £99.20. The payments I receive include my capital repayment plus the interest earned on it. I still have £114.88 invested in the 9 companies, and as of today there's £7.88 cash available. You need £20 minimum in your account to withdraw cash.
My total 'interest only' earnings so far is currently £24.25. After tax and fees it's £21.96.
Would I recommend investing in P2P lending?
I've been really pleased with the returns that I've received so far. The percentage yield is very high. I've heard that they can go into double digits, but I didn't expect to receive them personally.
I've been with Funding Circle for just over 18 months now, and to date I haven't received any bad debts. I'm not sure if that's typical or I've been lucky. Funding Circle actually recommend that you factor in 1% of the expected return to cover bad debts.
Would I recommend them?
As I've not experienced the negative side to P2P lending and I've benefitted from the nice side (high returns), I'm clearly very positive about Funding Circle and I would personally recommend them. However, I can hear a few of you readers asking.....
"So, why haven't you invested more money into it?"
I think I'm still in the process of deciding how good it is. It almost feels too good to be true, and you know what they say about that. I'm just waiting to lose some money there but it isn't happening. The loans are either 3 or 5 years, so there's a long time for things to turn out different. For the time being I'm happy with the situation, and maybe in the next 6-12 months I'll reassess where I want my money to be. If I max out my NISA allocation, which I'm hoping to do, this might be the next stop for my money until the new financial year arrives. I'm not sure yet!
Either way, I'll report back to you all on how this is going at the end of the year and we'll see if I'm still positive about it then. Until then I will continue to enjoy those lovely yields!
Recommend a Friend
Funding Circle have a 'Recommend a Friend' function where you fill in your friends name and email address. If they sign up via the link, and they deposit more than £1,000 you'll both get £50 cashback.
The offer below states it has to be done by end August 2014, but this offer has been available ever since I signed up, so I wouldn't be surprised if they update it again when the time expires.
Summer offer: introduce your friends to Funding Circle & share £100 cashback
It's easy to recommend a friend
- Add your friend(s) name and email address below. We will send them an email with details of how to join.
- Your friend starts lending. If your friend lends more than £1,000 to businesses before 31st August 2014, you'll each have £50 cashback* paid into your Funding Circle accounts.
- Enjoy your cashback. This will be paid within 40 days of the offer period close date.
You can recommend as many friends as you like as there is no limit on how much cashback you can earn!
If you like my post, and you're interested in trying out Funding Circle, let me know and I'll email you the link and we can get £50 cashback each. Feel free to open an account with them direct and bypass my link if you want to invest with less than £1,000 (or if you don't like me!).
If you do give it a go, please let me know how you get on!
If you're already with Funding Circle and you have some less positive feedback about your experience, please write a comment below.
Maybe you've investing in P2P lending with another company, please share us all your experience to date. I think it's important to get a balanced approach.
Thank you all for taking the time to read the post, please let me know your thoughts!
Labels: Extra Income