Social lending is becoming an all too easy sell: the banks are continuing to squeeze out borrowers and offer limp rates to savers, so why not lend to each other instead?
This concept of peer-to-peer (P2P) lending is becoming an important part of retirement planning too, with both Funding Circle and Zopa reporting an increasing number of investors opting to lend cash as a way to top up their pensions.
The big spenders at Zopa, those who lend more than £100,000, are aged 53 on average, compared with 45 for the overall average age of a Zopa lender. Over-fifties in pursuit of a pension boost are also pumping £375,000 into Funding Circle every month and currently have more than £3.3m invested, with an average account size at £4,200. In contrast, lenders under 50 have invested £2.8m and invest an average of £2,800 each.
"People saving for retirement are in a particularly difficult situation due to inflationary pressure and low returns from other investment products." says James Meekings, co-founder of Funding Circle. "Where Funding Circle comes in is that they get a good level of return and it allows them to boost their income for retirement. It is also a very transparent process; you get to see the good your money is doing and you get more control. It's quite an interesting and engaging thing to be doing."
It's easy to see why so many savers are now looking for alternative investments. With the Bank of England base rate held at 0.5 per cent for the 27th consecutive month, not only are savings rates still poor, but they are also failing miserably to keep up with inflation. Figures from the Office for National Statistics for May put the retail prices index (RPI) at 5.2 per cent and the consumer prices index (CPI) at 4.5 per cent. According to analysts Defaqto, basic rate taxpayers need to earn 5.63 per cent to beat CPI, and to combat RPI they need a 6.50 per cent return. This is no easy feat with only 14 accounts available giving a real return based on CPI and a pathetic six accounts based on RPI.
For investors who have used up the usual ISA and stock market investments, social lending sites are well placed to fill the gap. The first P2P website to come along was Zopa in 2005 and it has proved a success. Its lenders enjoyed average returns of 7.2 per cent over the past 12 months, which includes the Zopa fee of 1 per cent of the amount lent, but is before tax and any bad debt.
"The returns from Zopa lending are very attractive and relatively low risk, which makes a nice change from the stock market in which most pensions invest and far more sense than a savings account paying sub-inflation returns," says Giles Andrews, co-founder of Zopa.
Other sites have followed with a slightly different angle. For example, at Yes-Secure there is a social networking element with lenders offering money to borrowers they have a social connection with. Funding Circle has taken the concept further by offering loans to small businesses instead of individuals. Most of these sites offer similarly impressive returns for lenders; at Funding Circle they earn an average yield of 8.3 per cent, and even with fees and bad debts taken into account, estimated annual average returns of 6 to 9 per cent.
Such appealing returns are not risk free, however, and any given site is only as reliable as its members. Lenders must be aware that there is a significant danger that borrowers will default on loans.
The good news is that, to some extent, they are in control over the level of risk they take and loans are spread across several borrowers to minimise the risk. At Zopa, lenders choose the type of borrower they lend to – there are five markets to choose from ranging from A* borrowers with the highest credit scores to Young borrowers aged 20 to 25 – and whether to lend for three or five years.
At Funding Circle, there is an inherent danger because the borrowers are small firms that could easily face cash-flow problems, go bust and default on their loans. However, as with Zopa, the loan is spread across different businesses and all borrower companies must have at least two years of audited accounts to be eligible for a loan. Lenders are also free to inspect the accounts of prospective borrower companies and ask questions about how they will use the loan.
The sites do much of the legwork themselves by organising their own credit checks on borrowers and chasing up any overdue payments using a debt collection agency. Social lending is in many ways more flexible than other investments. Zopa lenders can cash out some or all of their money by transferring unpaid debt to another user, subject to a 1 per cent administration fee. At Funding Circle, loan parts can usually be sold to other lenders with a fee of 0.25 per cent.
Despite all the checks in place, however, a major turn-off for many investors is that deposits held with social lending sites are not covered by the Financial Services Compensation Scheme, so if they lose their money, it's gone for good.
"People have got to be cautious with any alternative investment. While the returns can be attractive, there is no such thing as a free lunch, and inherently if you get a better return that is generally because there is more risk involved," says Dan Clayden from independent financial adviser (IFA) Clayden Associates.
"The concern I have is that people might go into this without all the facts and without taking into account the risks. If you've got £10,000 you'd be a very brave man to put it all into something like this, but as part of an overall portfolio it's definitely worth considering," he adds.
Mark Barry-Jackson, 62, Semi-retired helicopter pilot
Mark Barry-Jackson was looking for a way to supplement his pension. After reading about Funding Circle and social lending in his home town of Reigate, Surrey, he gave it a try.
"I used to run a small business myself so I liked the idea of lending to businesses, and I don't like banks and the way they treat their customers and savers," he says.
He started off gently with £500 last November, but was quickly impressed and topped it up to £10,000 when he received some money from a drawdown arrangement and is now enjoying an average yield of 9.4 per cent.
For Mark, another big incentive outside of the returns is the flexibility and the ability to sell loan parts to other lenders if he wants to get his money back. "I do have stock market investments and contribute to a Sipp but it's not very flexible. Once it's in there you can't get your hands on it easily. I use my full stocks and shares ISA quota so that is working away, but for any spare, Funding Circle is a good route," says Mark.Reuse content