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Peer to peer loans explained

Peer to peer loans explained

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Last updated: 11 August 2021

Peer-to-Peer (P2P) loans is a relatively new form of borrowing and lending outside of the traditional financial institutions. As a new sector of the economy, peer-to-peer loans carry more risk than borrowing and lending in the usual way. 

However, with these risks can come high rewards, as peer-to-peer lending is digital and avoids the normal overheads a bank or building society would have. Therefore, the best way to view peer-to-peer lending is as an investment as opposed to savings. 

This guide will take you through how these digital loans work and allow you to compare peer-to-peer with other loans to help you make the best choice for your financial situation.

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What is peer to peer lending?

Peer to peer lending is a way of borrowing money without having to go through a bank. Peer to peer lending websites are essentially a digital marketplace, linking people and business that want to lend or borrow money, in many ways these websites act like a financial matchmaker. 

As a lender, it is similar to putting savings into a bank apart from one crucial difference, there is the possibility of losing money. As a borrower, it can be useful for those who have struggled to get a personal loan elsewhere, although you are not guaranteed to be accepted.

How does peer to peer lending work?

Because peer-to-peer lending operates through many different websites, there is no one single way in which they work. For instance, some P2P platforms will allow you to choose who you lend to, whilst others will make you spread out your investment across multiple borrowers.

If you are borrowing, you will be checked with a credit reference agency and pass the websites own tests. It’s often the case that peer-to-peer lending can be used by those who would otherwise be refused a personal loan. If you are lending, some websites will allow for you to use these credit scores to decide who to lend to. If you are lending money, it’s important to remember that you will have to report to HMRC how much interest you have made as it falls under taxable income.

If you are seeking to lend money, it’s generally speaking quite straightforward. You simply open an account with a peer-to-peer lending platform and set the interest rate that you would like to receive or the one that’s on offer, and the lend for a fixed period of time.

Advantages of peer to peer loans

  • By cutting out the overheads traditional high street banks would use, P2P sites will often give much more favourable interest rates than traditional lenders.
  • They can be useful if you are a borrower who has struggled to get a personal loan from the bank because of your credit history.
  • The online application process for borrowing is quick and convenient, allowing you to borrow money quickly.
  • Applying for an initial quote will generally not affect your credit score. Most P2P lending sites will only perform a ‘soft search’ on your credit history so it will not show up in the future if lenders are determining whether to give you a loan.
  • Peer to Peer loans are a form of unsecured borrowing, meaning that you will not risk your high-value assets (such as your house) should you default.

What are the risks of peer to peer loans and lending?

Peer to Peer lending is a very risky business, and if you are looking to just safely accumulate interest on savings then this is not for you. However, if you see it as a risky way of increasing capital then it can be very effective. 

It’s important to understand the risks and what to look out for when you are comparing loans and lending:

  • There is a chance that the person you lend money to fails to pay it back. Because P2P is outside the traditional methods of lending, you’re not covered by the Financial Services Compensation Scheme, although some websites do have contingency funds if this happens.
  • You could end up losing your money if the website goes bust, but in the UK they must be regulated by the Financial Conduct Authority and therefore ring fence lenders’ money away from their own.
  • As with anything, the uncertainty around Brexit could cause issues with this new form of borrowing.
  • Your cash is not necessarily lent out straight away, therefore you could earn no interest for a while.

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Fergus Cole

Author: Fergus Cole

Fergus is a journalist specialising in the personal finance, energy and broadband sectors. He also has a passion for travel and adventure so tries to make the most of this in any spare time he gets.

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