How can peer-to-peer loans and savings offer better rates?

Online dating for lenders and borrowers. That’s P2P loans and savings in a nutshell.

Peer-to-peer websites are a new and fast-growing type of alternative saving. The big attraction is that they can offer more competitive rates and more flexible terms. That’s because they ‘cut out the middleman’ with no banks or other financial institutions involved.

The best-known platforms include Funding Circle, Zopa and Ratesetter. They work by matchmaking between lenders and borrowers: introducing individuals and companies who want to borrow money to investors who want a better return than conventional savings can offer. Some P2P platforms only lend to businesses, others only to individuals and some to both.

A new kind of ISA

Peer-to-peer saving really started to take off in April 2016 when P2P ISAs were launched (they are also known as Innovative Finance ISAs). Since that date, savers have been allowed to use one peer-to-peer ISA per year as part of their annual tax-free savings allowance. This is currently £20,000 per year.

Risk v return

Is there a catch? P2P investments are not protected by the Financial Services Compensation Scheme. This automatically reimburses savers if their bank goes bust, up to a limit of £85,000. However peer-to-peer platforms are now regulated by the Financial Conduct Authority, which insists that peer-to-peer firms must present information clearly, be honest about risks and have plans in place should something go wrong. So users of P2P sites are better protected than ever before.

Perhaps the best way to think about peer-to-peer ISAs is that they are cross between saving and investing. They carry less risk than stocks and shares ISAs, but more risk than cash ISAs. So having one of each type in your portfolio is an excellent way to balance risk and return – especially with cash ISAs offering the lowest ever interest rates at the moment.