Zopa takes up where the banks leave off

Julian Knight and Nargis Ahmad look at the site matching individual lenders and borrowers who recoil from high-street rates

Savers and borrowers alike are struggling in the back- draft from the credit crunch. The return on savings has been slashed dramatically following a series of Bank of England rate cuts. On the other side of the coin, borrowers have seen credit-card, loan and overdraft rates rise as banks grow ever more reluctant to lend. Even people with a good credit history are being charged more or refused a loan altogether.

Against this backdrop, any initiative that offers to cut out the banks is bound to appeal. This is where Zopa.com, the money-exchange website, fits in. It styles itself as a market offering "loans from people, not banks". Basically, it matches individuals with cash to lend to individuals looking to borrow.

Zopa was formed in 2005 and from small beginnings, business has boomed as the credit crunch unfolds. The concept behind the service is that lenders deposit money with the site, which is then advanced to other users. The loan is repaid over time at a set rate of interest.

"Zopa is a lending and borrowing marketplace. There is money available to borrow, unlike at some high- street banks," says Giles Andrews, managing director and co-founder of Zopa. "Business is good. Lenders are coming to us because of the potential of better returns than on savings and borrowers because rates can be lower than with the banks."

Andrew Hagger, from the financial advice website Moneynet.co.uk, admits that when Zopa was launched, he had misgivings. These, he says, have eased over time. "I was worried about the possibility of savers losing out due to borrowers defaulting, but after three years there is no sign of this. The key is that, through precise credit scoring, Zopa does tend to be careful over who gets the loans." Indeed, Zopa says it rejects around half of all loan applicants and carries out more checks than the banks, not only looking at credit histories but assessing whether or not the borrower can afford the repayments.

Mr Hagger adds that the Zopa concept plugs into the anti-bank zeitgeist. "People feel differently about banks; they are no longer trusted. So if they can be taken out of the equation then that is a powerful draw," he says.

Lenders can choose their own rate of interest and pick who they want to receive their money. The cost to lenders of using the service is a 1 per cent fee of the total value of the loan.

However, this is no short- term commitment. They have to tie their money up for either three or five years. The amounts deposited start at £10 and go up too £25,000.

Switching to the other side, borrowers can take out a loan of between £1,000 and £15,000, which again will be repaid over three or five years. There is also a fee payable to Zopa of £94.25, but unlike with some banks, there are no charges for early repayment of the loan.

When signing up to the site as a potential borrower, your credit history will be checked and this will determine which band you fall into and the subsequent interest rate charged. There are five bands – A*, A, B, C and "Young" – with A* the most credit-worthy and C the least.

Borrowers aged between 20 and 25 are put in the "Young" category. Traditionally, people in this age range have struggled to get credit as they have no history of taking out or repaying loans.

Advancing money to borrowers in bands B or C will mean lenders receive more interest, but there is extra risk in doing so.

The returns on offer seem eye-catching: the site advertises that lenders have earnt an average of 9.1 per cent. Borrowers don't fare too badly either. For example, £5,000 borrowed over three years currently attracts an interest rate of 7.3 per cent. This makes Zopa a "best buy", though people in higher-risk categories can expect to pay more.

Understandably, given the troubles that have assailed banks over the past 18 months, savers are putting safety at the top of their checklists. To minimise any risk, Zopa will typically split a sum of £500 between 50 borrowers to reduce the risk of losing money. Be aware, though, that Zopa is not a bank, so lenders do not have the safety net of the Financial Services Compensation Scheme.

Borrowers who miss repayments are charged a fee, and debt-collection agencies may be employed to chase defaulters. Although only around 0.2 per cent of borrowers have defaulted on their loans so far, there is a chance that those who advance cash might not get it back. And with the economy worsening, most analysts agree that lenders, of any hue, are going to suffer a rise in the level of bad debts.

"Like high-street banks, social lending websites use debt-collection procedures to get the money back," says Richard Mason, spokesman for financial advice website Moneyextra.com. "But the loans are unsecured, which is a potential problem.".