What is peer to peer lending?

Peer to peer lending, or 'P2P' lending, is an alternative method of securing funding without the help of traditional financial institutions. Here's everything you need to know.

What is peer-to-peer lending?

Peer-to-peer (P2P) lending is a form of debt financing that allows individuals to borrow and lend money without the use of an intermediary such as a bank. In other words, it's a way for people to borrow and lend money directly from each other. This type of alternative business funding has existed since around 2005 and has become increasingly popular, as it offers borrowers a number of advantages over traditional loans from banks. Businesses use peer-to-peer platforms to help fund projects at more attractive rates.

In a typical peer-to-peer lending transaction, the borrower and lender will connect through an online marketplace that acts as a matchmaker between them. The borrower and lender agree on terms for repayment or interest-only payments. Peer-to-peer loan sizes tend to be the same as small business loan sizes – between £5,000 and £500,000.

With peer-to-peer lending, lenders (also known as investors) have the opportunity to secure higher rates of return through interest, when compared to the traditional saving models offered by a bank. For those looking to borrow money, peer-to-peer platforms promise fast and simple applications, often paired with lower rates than the high street lenders.

Most peer-to-peer platforms will offer services for investors and borrowers to ensure the transaction works best for all, including security features that enable borrowers to match safely with lenders, identity verification processes, credit checks and marketing tools to help identify new lenders and borrowers.

How does peer-to-peer finance work?

Peer-to-peer providers connect borrowers directly with investors. Each platform or website offers different interest rates that work in tandem with the borrower’s individual credit score.

Investors:investors open a lender account and deposit a sum of money as an individual loan – some peer-to-peer platforms offer the opportunity for the investor to divide this into smaller chunks for safer investing across multiple offers.

Borrowers:the peer-to-peer platform assigns the borrower a risk category, which then dictates how much interest they must pay on the loan. Sometimes investors can ‘haggle’ with potential borrowers, or sometimes the process is fully automated.

£12bn has been invested since 2005

Peer-to-peer lending pros and cons

Advantages of peer-to-peer lending

  • Speed: you don’t have to apply for a loan and wait for approval, so you can get access to funds quickly and easily.

  • Flexibility: repayment terms are usually much more flexible. You can select what day of the month you’d like to make repayments on, and usually offer to make an overpayment and settle your loan early.

  • Rates: borrowers typically get a lower rate using P2P lending, while lenders can generate a higher return on investment.

Disadvantages of peer-to-peer lending

  • Fees: P2P lending can sometimes be more expensive than traditional loans. For example, it may cost you more in arrangement fees for each transaction made through P2P than a bank would charge if it was lending money directly to its customers.

  • No guarantee of an investor match: there's no guarantee that lenders will find suitable matches for borrowers.

  • Approval rate: you’ll have a credit check, so it may be difficult to be approved if you have a poor credit history.

Continue reading to learn more on the safety of P2P lending and how to select the best lending platform.

How safe is peer-to-peer lending?

As with any loan, there’s a risk to peer-to-peer lending, but it can be a safe way to access money if you do not qualify for a bank loan.

The good news is that all peer-to-peer lending platforms in the UK are regulated by the Financial Conduct Authority (FCA). For borrowers, this provides added protection if things go wrong. In addition, most peer-to-peer lending platforms have strict vetting procedures in place for both borrowers and lenders.

For lenders, one of the benefits of peer-to-peer lending is that they can spread risk by investing in a number of different loans. This means that if one loan goes into default, there’ll be less impact on their finances.

Selecting the best peer-to-peer lending platform

As a borrower, there are several factors that you’ll want to consider before selecting a peer-to-peer lending platform. The more research and diligence you conduct, the better the repayment terms you’re likely to get. These factors include:

  • Lending rate: make sure that your selected platform offers the right rates for the amount of money that you’d like to borrow.

  • Your credit history: this’ll impact the amount of money that investors are willing to offer you.

  • Company history: lending platforms will consider how long your company has been in existence.

  • Business size: small businesses are typically offered lower amounts and higher rates due to the increased risk.

Peer-to-peer lending and taxes

When it comes to peer-to-peer lending and taxes, this only applies to the lending party. Any interest lenders make on the loan will be taxable in the same way that tax is paid on other forms of income. So, lenders would need to contact HMRC if they receive interest payments without a tax deduction. If the borrower doesn’t repay the loan, then lenders can offset any losses against the interest they’ve received before they pay tax.

What’s the difference between peer-to-peer lending and crowdfunding?

Peer-to-peer lending and crowdfunding are quite similar methods of funding. Both are alternative methods for businesses or individuals to gain funding, which involve individuals investing in a project or a business,

However, peer-to-peer lending and crowdfunding can be quite different. Here’s why:

Crowdfunding is often used as a word to generalise funding that comes from the public. Reward-based crowdfunding and equity crowdfunding are two specific examples: they offer rewards, such as a gift from backing a Kickstarter project – or a stake in equity from a successful round of funding. Peer-to-peer lending, however, rewards its investors by paying a percentage in interest back.

There’s a risk with crowdfunding that the investor may lose their original investment completely if the project fails. For the business seeking funds, it’s clear to see the advantages. Generally, crowdfunding lends itself well to those with high knowledge in a subject, as well as hosting a closer relationship between the two parties. Peer-to-peer lending is a significantly less risky method of investing as it makes more reliable returns. It comes with its own risks but is usually a safer option than taking a punt on a new company’s shares.

Discover some P2P lending alternatives below.

Alternatives to peer-to-peer lending?

Business Loans: a common alternative for borrowers is to apply for a business loan. With an iwoca Flexi-Loan, you can borrow up to £500,00 across 24 months with no early repayment fees.

Recovery Loan Scheme: the Recovery Loan Scheme allows businesses that have been impacted by Covid-19 to apply for a loan between £25,001 - £750,000.

Business Credit Cards: if you are looking for a short-term fix to purchase inventory or support cash flow then a business credit card might be a suitable option.

Customer Financing: offering flexible payment terms to your customers via iwocaPay can help improve short-term cash flow.

More to read on business funding options

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Ed Cooper is a freelance writer, and digital editor at Men’s Health UK who has written for publications such as The Telegraph, Runner’s World and Escapism magazine.

Article updated on: 22 April 2022

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