Social Lending | Peer to Peer Borrowing
What is Social Lending?
How it all started
Who can use Peer to Peer Borrowing facilities?
What are Social Loans used for?
The benefits of social lending
How Peer to Peer lending facilities are charged?
How are savers protected from lending risk?
How are Social Lending Providers regulated?
What to do if you want to save with a social lending provider
Tax liability of Peer to Peer Lending
The way forward
Just as money developed as a direct result of individuals needing to exchange goods and services more efficiently, and banks developed to facilitate this process, Social Lending has now been created to provide a more fluid and efficient exchange of funds for savers and borrowers alike.
Over recent years, poor interest rates on savings, high interest charged on loans and the limited number of loans being offered by traditional banks during the credit crunch has meant that more and more of us are turning our backs on the old-style of financial activity and are looking for something new. And many believe that Peer to Peer Lending could be providing exactly that opportunity.
What is Social Lending?
Also known as Peer to Peer Lending, Social lending takes banking back to its roots. It arises when one individual lends to another unrelated person without going through the standard banking process.
As the entire procedure involves individuals rather than institutions, there are no payrolls or branch buildings to fund, there is less administration which means that peer to peer borrowing is able to offer higher interest rates for savers and lower rates for borrowers without worrying about ever mounting overheads. This can be a much more efficient and competitive process for everyone involved.
And as bank interest rates continue to worsen and the grip on who is actually eligible for a traditional bank loan tightens, the advantages of social lending become more and more apparent.
How It All Started
Peer to Peer banking in Britain started back in 2005 with the launch of Zopa, the first and now one of the leading social lending service in the UK.
By asking savers to register and deposit their funds, with the direct intention of lending them to Zopa accredited borrowers, today this social lending facility has more than 45,000 active savers benefiting from the higher rates of interest that peer to peer borrowing can offer, while 71,000 borrowers have gained access to funds at a significantly lower rate than those provided by the traditional banking system (source: https://www.zopa.com/about)
Individuals are able to create their own account and then the system itself will match people who want to borrow or save money with a suitable partner.
It’s aim is to create a flexible, competitively rated agreement that will suit both the borrower and the lender.
What’s more, these loans come with no early repayment fees or further hidden charges and have been so attractive in today’s UK economy that Zopa alone have helped individuals lend over £400 million and have been Moneywise’s ‘Most Trusted Personal Loan Provider’ for four years.(source: http://www.zopa.com/awards)
Since the rise in popularity of social lending, more and more peer to peer lending providers have established themselves within the market place. Two other more noticeable providers are Funding Circle and Ratesetter.
Who Can Use Peer to Peer Borrowing Facilities?
Anyone who applies to a social lending facility and passes their initial assessment process can register to save or borrow with a peer 2 peer lending facility.
Do be aware that the standards required do differ between lending facilities. Most do not use the traditional credit scoring facility however it is wise to check with the specific facility before you enter any agreement.
In general, it is expected that even those of us who have been turned down by traditional banks, can still gain funding from social lending organisations.
What Are Social Loans Used For?
Low rate social lending loans can be used for almost any type of activity or purchase. They are usually relatively small amounts but can still provide funding for buying a car, carrying out home improvements or any other traditional loan type activity.
It is likely that a peer to peer loan will provide the same funding as a standard bank, but at a more competitive rate.
Furthermore, many peer to peer lending facilities will also allow you to apply for loans to fund business activity. Though the loan will still be agreed between two individuals, if you provide complete and full information on the intended purpose of your activity at the outset, almost any activity is considered.
The Benefits of Social Lending
To most people, the key benefit of social lending is the significant improvement in interest rates that are available. Whether this comes in the form of lower rates for borrowers or a higher rates for those wish to save with a social lending facility. But there are other benefits too.
A large proportion of social borrowing facilities do not base their lending profile on the old-style standards of traditional banks. This means that even people who have been turned away by their traditional bank due to the credit crunch may still be able to gain funding with a peer to peer lender.
Furthermore, social lending providers remove the need for large traditional banks that can be seen as being inefficient and self-seeking in the way they operate. Instead individuals lend to individuals and cut out the need for the financial giants that many traditional banks have seen to have become.
In addition, most social lending facilities are set up on a regional basis. This means that savers are not only using their funds to gain a higher rate of return for themselves, but their money is also being used to benefit the community around them.
One good example of this is minibus salesman Dave Fishwick from Burnley who set up ‘Burnley Savings and Loans’ to provide lending facilities to the individuals and business who had been turned down by the traditional banking system in the local area.
With the catchphrase ‘Bank On Dave’ (a channel 4 television program which I’m sure many of you will have seen), this organisation ensures that all the funds lent are given to individuals or firms who require financial assistance to improve the town as a whole. And along with the financial support, borrowers can also benefit from the business acumen of the very successful Dave Fishwick further increasing their chances of profiting from their funding and making the very best of the assets they hold.
For savers, they are safe in the knowledge that the profits made on their money are never going to line the pockets of corporate fat cats. Instead they are enjoying improved interests on their savings, making it possible to supply for more cost effective, readily available loans to the community in which they live and, when it comes to Burnley Savings and Loans, all further profits are then donated to charity.
How Peer to Peer Lending Facilities are Charged?
Social lending facilities are financed by a combination of fees and interest rates.
Savers registered with a social lending site will traditionally pay an annual lenders fee to fund the administration and overheads associated with making the loan and managing the overall account.
In the same way, borrowers taking money from the agreement will usually pay a one off borrowing fee at the outset of the loan and then pay an agreed interest rate throughout the duration of the loan.
Unlike traditional banks, there are usually no default charges or hidden penalties on a social lending facility and all interest rates and fees are agreed clearly and directly up front. This means there are no nasty surprises down the line.
All APR’s quoted for both savers and borrowers should include all fees and annual charges but always make sure you read the small print to ensure you are comparing like for like.
Furthermore, it is very often the case that the cost of the lending fee can be incorporated into the low monthly repayments. This will ensure complete affordability throughout the lifetime of the loan.
How Are Savers Protected From Lending Risk
When a traditional saver puts money into a bank, they are covered by the Financial Services Compensation Scheme. This protects the first £85,000 of savings per institution for each individual saver.
Though peer to peer lending facilities are not legally required to offer the same sort of guarantees for their savings, most have still opted do so.
Companies such as Zopa will offer a safeguard to their savers which guarantees that if a loan is defaulted, they will personally pay back the outstanding amount to the saver. This makes the risk to the individual far less than if they were simply to lend to the man on the street, yet the benefits in terms of higher interest rates are much more attractive than traditional bank savings.
Other peer to peer lenders have opted not to provide such protection and feel that the cost of doing so is not what their customers want. Instead, they say they are able to provide a higher rate of return to their savers, which is what they feel their customers would prefer.
FSCS / Financial Services Compensation Scheme: http://www.fscs.org.uk
How are Social Lending Providers Regulated?
Peer to Peer Lending Providers are not considered banks and are therefore currently not subject to control by the Financial Conduct Authority / FCA.
Peer to peer lenders can join the Peer to Peer Finance Association which, itself, requires a minimum level of capital holdings and legislates how individual savings should be managed.
Today Social Lending services are supervised by the Office of Fair Trading to ensure all customers are treated fairly and that business operations are legitimate. However it is expected that by April 2014 all peer to peer facilities will come under the control of the Financial Conduct Authority and will be required to meet both customer protection and some financial services rules with the aim of bringing even further security to both the lender and the borrower.
What to Do If You Want To Save With a Social Lending Provider
If you want to lend to individuals or small businesses via a peer to peer lending facility, the first step is to decide on the type of lender you would like to use.
Consider the profile of the company in question and whether it fits with your own attitude to risk.
Also assess their own track record of success.
If you can, review their bad debt record to see how successful that lending institution has been in assessing the viability of their own borrowers and understand their growth rates in both borrowers and lenders over recent years.
Many institutions in this sector are relatively young, with new businesses being introduced almost daily, so make sure you are aware of your own investment risk from the outset.
Many lenders prefer to start with a relatively small amount of investment to trial the system before considering placing all their funds into the system to make sure the return, risk and structure of the process suits their profile. And once you have appreciated the benefits of this type of investment, the rewards can really start to be appreciated.
Tax Liability of Peer to Peer Lending
In the same way that interest on traditional savings is liable to taxation under the UK income tax rules, income generated from savings used to lend in the peer to peer facility are also taxable.
However unlike traditional banking facilities, income tax is not deducted at source and it is the responsibility of every saver to declare these earnings in their annual tax statement.
For those of you that have not had to manually declare tax previously, using the peer to peer system will require completion of an annual self-assessment form.
Please note, fees and charges levied within the social lending facility are tax deductible but, under the current system, tax will be liable for the entire interest earned over the life of the loan, even if the borrower defaults and the funds are not returned.
The Way Forward
For some people, like Dave Fishwick, peer to peer lending is the way of the future. It enables a more efficient flow of funds to those of us that really need it without unnecessary and costly central control.
Social lending can provide a greater level of income to the saver and a lower cost level to the borrower by eradicating the need for the high salaries and overheads that are so often reported in the media.
However there are some drawbacks to this type of facility. The current lack of protection for savers in some social lending institutions and the lack of uniformity in the way that borrowers are assessed can be a concern. Yet the growth of popularity of peer to peer lending, both online and in certain regional areas, shows that many individuals are seeing this as an investment opportunity they cannot ignore.