Peer-to-peer lending rates put Nisas to shame

The returns from P2P providers look more attractive than ever

Many people who have put their savings in cash-based new Isas (Nisas) to avoid paying tax on their interest will be dismayed at the level of returns currently on offer.

Unfortunately for savers, the Isa market offers the same dismal outlook for the savings market as a whole. With rates at rock bottom and little sign of improvement, it could pay to consider peer-to-peer lending, an alternative and more rewarding investment option.

The returns from P2P providers look more attractive than ever. RateSetter, for example, is currently offering 4.2 per cent for a one-year bond. Even if you deduct 20 per cent tax, the net return is 3.36 per cent AER and is in a different league from the best one-year fixed-rate Isas from Shawbrook Bank and Virgin Money, paying just 1.75 per cent and 1.71 per cent respectively.

In cold, hard cash terms, 1.75 per cent interest on the maximum cash Nisa allowance of £15,240 would give you a net annual return of £266.70, compared with a far healthier £512.06 net from the RateSetter one-year bond option.

Zopa remains the biggest player in the P2P market, having lent more than £1bn, and is equally competitive with its rates. It boasts more than 59,000 lenders, which isn't surprising as it advertises a 5 per cent return over five years.

RateSetter is growing fast, too, with an inflow of more than £40m in the past month alone. It even offers a monthly access account paying 3.1 per cent (at the time of writing) – so even the most cautious investors can dip their toes in the water and try it out with a minimum deposit of just £10.

Lending Works is another straightforward retail P2P provider. It is currently offering 4.8 per cent fixed for three years and an impressive 6.3 per cent for a five-year term.

If it's the level of net interest earned that's important to you then P2P wins hands-down, plus you're not restricted to a maximum annual allowance as with a Nisa. So if you wanted to save £20,000, or even £50,000, that's an option.

One of the main concerns for people depositing their cash with P2P providers is that although the returns far outweigh those paid by the banks, they don't offer the cast-iron guarantee that your savings are protected – an assurance that bank customers enjoy under the Financial Services Compensation Scheme.

As long as you are comfortable with this, the lower overheads of not having to run a nationwide network of branches means you can obtain better returns on your cash in the P2P market.

Providers also have their own systems in place to protect depositors. RateSetter, for example, maintains a "provision fund" with a balance of over £15.3m built up from borrower fees. The fund is used to reimburse lenders in the case of late payment or default.

This safety net has ensured that, since it started almost five years ago, every penny of capital and interest has been returned to every single lender.

Zopa operates a similar model with its "Safeguard" feature, while Lending Works utilises a reserve fund and unique insurance scheme to protect lenders' cash.

As long as rates remain competitive and bad debts are kept under control, P2P should become an even bigger thorn in the high-street banks' side, particularly when it enters the Isa market in April 2016.

If you're fed up with the poor returns from banks, maybe it's time to look elsewhere.

Andrew Hagger is an independent personal finance analyst from www.moneycomms.co.uk