The easiest way to understand investment made through peer to peer lending is that it is not like the investments you make through a UK savings account. When you deposit savings in a bank or a building society, your money is covered by the Financial Services Compensation Scheme (FSCS). The FSCS provides a guarantee to compensate for your savings of up to £85,000 if the bank or building society goes bankrupt.
However, with p2p lending, there is no such guarantee provided. By investing through a peer-to-peer lending platform, you have to be prepared that high returns’ potential comes with an increased level of risk. If you are searching for investment options that are free of risk, you have to understand that there are no risk-free investments. But it does sound great. You should not be discouraged by the fact that your investment will not be 100% free. Looking into different investments is good as long as you completely understand how everything works and what risks are involved.
The peer to peer is a market that exclusively brings together the borrower’s demand for funding and the supply from investors. There is a specific risk involved when you invest in peer to peer loans, and you must know how you can safely and successfully mitigate those risks.
Are the P2P firms regulated?
In April 2014, the Financial Conduct Authority of the UK regulated peer to peer lending industry. The FCA has set some clear rules which protect investors. For example, an individual’s money has to be held in segregated money accounts, which are protected in case the peer to peer firm goes bankrupt.
(Note: this only applies to the funds held in your account and not the money that is lent to borrowers.)
Every p2p firm must have a contingency plan in place that ensures that loan books are managed to maturity if a P2P Company goes out of business. The alternative savings are evolving, and the FCA is evolving its policies as well.
The Default risk
The main risk that an investor needs to worry about is the risk of default i.e., where a borrower doesn’t repay the complete amount of the loan. Just like with other types of investments, you can decrease the risk with diversification.
Wrong assessment of creditworthiness
Another possible risk is the credit rating, which can be wrongly estimated at times. It is possible that credit ratings aren’t assessed correctly, or there is a possibility that borrowers lied about their information. In such situations, the credit risk is underestimated, and the default on loans is higher than the expected default. However, you can reduce the risk by carefully reading and clarifying credit projects, specifically at the beginning. Besides, it’s better to spread your investments over different borrowers.
Peer to peer marketplace collapse
There is always a risk of peer to peer lending firm going bankrupt. The majority of firms have some kind of security in place to protect their investors. Such backup security functions like a detached unit from the p2p firm to ensure borrowers’ complete security and investors money. The firm manages the whole end to end process without any human intervention.
Therefore, peer to peer lending is a captivating and intriguing investment alternative brought to light by the Fintech industry. The platform offers private investors a new asset class and loan seeking borrowers a less bureaucratic alternative to the bank loans. Remember, just like with any other investment, high opportunities also carry risks which have to be known and minimized.
Peer to Peer lending schemes tax implications for investors
Unless you have invested through an IFISA, the interest gained via p2p lending is UK tax. The interest earned through p2p is similar to savings interest for HMRC.
In the 2018/19 tax year:
- Basic rate taxpayers can earn £1,000 of interest yearly with no tax.
- Higher rate taxpayers can earn £500 of interest yearly with no tax.
- Additional rate taxpayers don’t get an allowance.
- If you over your ISA allowance, any interest that you gain will be taxed at marginal tax rate (i.e., the highest rate of the tax that you pay)
In a nutshell
Please remember that tax rules are frequently changing. Therefore, you must do your research about your investment’s tax implications made in peer to peer lending platform.