Glossary

Peer to Peer Lending

Peer to peer lending

Whether you need an injection of cash to pay off debt or you're looking to raise additional capital to help fund research for a new product, peer to peer lending provides businesses with a non-traditional loan.

What is peer to peer lending?

Peer to peer lending is a relatively simple way for investors to lend money to individuals and businesses who are looking to raise capital relatively quickly. Peer to peer lending (P2P) is an attractive form of investing for people with private capital to invest because it often offers greater returns compared with traditional savings accounts.

There are several different types of P2P lending, but the main ones include:

  • -Individual lending: The most simple type of peer to peer lending definition and where it originated. Individuals take out a personal loan funded by a number of investors. The borrower then pays back the loan over the agreed period with the agreed interest.
  • -Company lending: This can either be a simple business loan and is treated like individual lending, or it can be what's known as 'invoice finance.' Invoice finance works by the company borrowing an amount from an investor(s) against future cash it has coming in from invoices. I.e., When the company's customers pay the invoice, the company pays the loan back with that income.
  • -Property lending: Property sourcing is becoming a massive part of the property market, and this is where investors usually lend an amount to a developer or property investor to either build or buy property. Once the property is sold or let, the loan is repaid, plus interest.
  • -Underwriting: Whilst risk cannot be eliminated and even borrowers with good credit history can default on a repayment, platforms that are FSCS regulated have strict underwriting processes in place to limit the risk of borrowers defaulting.
  • -Contingency: Many P2P platforms recover the debt as soon as a borrower misses a repayment, with some platforms offering contingency funds to cover any missed repayments so the lender doesn't lose out.
  • -Diversification: Having a diverse investment portfolio is essential for the long-term success of investors, and P2P platforms use various algorithms to asses peer to peer lending trends to average out the default rate and ensure only a small amount of capital is at risk should a borrower default.
  • -A useful alternative to banks and traditional loans, especially for those who have been unsuccessful at gaining funding through conventional methods
  • -Most P2P transactions take place online, making the process quick and easy
  • -Repayment terms tend to be fixed monthly repayments with lower interest rates compared with banks
  • -Many are unsecured loans, so business or personal assets aren't at risk
  • -When checking different loan rates, credit scores aren't affected
  • -Usually more flexibility with how the loan is spent

How does peer to peer lending work?

Peer to peer lending works by matching borrowers with lenders. Traditionally this was done through a broker, however, increasingly it's being done online through dedicated peer to peer lending platforms.

If you're looking for online peer to peer lending, you'll need to apply to a P2P platform and complete the relevant forms. Based on the information you've submitted, you will be subject to a credit check to gauge your suitability and this will impact the APR you'll be quoted.

Once you're happy with the terms set out, an underwriter will make the final decision about your lending terms and whether you're a suitable candidate to receive the loan. Once the loan has been paid, you will need to make the repayments set out in the terms, which will then be passed onto the individual lenders.

Peer to peer loans can be secured and unsecured, so making sure you understand the terms of the loan is important.

Peer to peer lending market size in the UK

Peer to peer lending has been steadily growing since 2012, and in 2020 amounted to 4.02 billion British pounds and peer to peer lending platforms have grown by 26.6% between 2016 and 2021.

Unsurprisingly, the peer to peer lending market is driven by SME financing as small businesses tend to struggle to receive the capital they need from traditional financing avenues, whilst investors are turning towards P2P lending as it offers them more favourable returns and provides excellent opportunities for them to diversify their investment portfolios.

How safe is peer to peer lending?

Peer to peer lending platforms are regulated by the Financial Conduct Authority (FSCS), however, P2P lending itself is not covered by the FSCS and you can search their register to find which platforms are regulated. This protects lenders from malpractice by the provider, however, if the platform itself goes bankrupt, the lender's money could be lost.

Like any form of investment, peer to peer lending puts capital at risk, however, safeguards are put in place to ensure lenders' risks are low.

Peer to peer lending FAQs

What are the advantages and disadvantages of peer to peer lending?

Like all forms of lending, there are advantages and disadvantages of peer to peer in business.

Advantages

  • -A useful alternative to banks and traditional loans, especially for those who have been unsuccessful at gaining funding through conventional methods
  • -Most P2P transactions take place online, making the process quick and easy
  • -Repayment terms tend to be fixed monthly repayments with lower interest rates compared with banks
  • -Many are unsecured loans, so business or personal assets aren't at risk
  • -When checking different loan rates, credit scores aren't affected
  • -Usually more flexibility with how the loan is spent 

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    Disadvantages

    • -Those with poor credit may incur high interest rates or may not be accepted at all
    • -Typically a £30,000 limit on borrowing
    • -Some online peer to peer lending platforms charge high fees, including early termination and late repayment
    • -Defaulting on repayment will affect your credit score
    • -If you've been refused a bank loan because of affordability reasons, it could be a risk to take another form of debt
    • -How much do you need to borrow?
    • -How will you use the funds?
    • -How much interest is charged?
    • -Are there other fees?
    • -What are the terms of the loan duration?
    • -Are there any charges if the loan is paid back early?
    • -What are the charges if you default on a repayment?
    • - Can you afford the loan and any additional fees?
    • -Does this debt benefit the company long-term?

    Do you pay tax on peer to peer lending?

    Yes. Any money received through peer to peer lending is seen as income and is subject to tax. However, if you open an Innovative Finance ISA (IFISA) you can receive interest from P2P loans tax-free and avoid being taxed on any capital gains and you won't need to declare any ISA interest, income or capital gains to HM Revenue & Customs on any gains in an IFISA.

    What's the difference between equity crowdfunding (ECF) and peer to peer financing (P2P)?

    In recent years crowdfunding has been a great way for SMEs to raise capital and even big businesses like Sony have used crowdfunding to fund new projects. Peer to peer financing is a form of crowdfunding. However, the key difference is unlike equity crowdfunding where the investors get a share in the company (equity), peer to peer lending is more of a loan with more traditional repayment terms.

    Peer to peer loans tend to be better suited to established businesses who know they are able to make the monthly loan repayments.

    What are peer to peer lending platforms?

    The majority of peer to peer lending occurs online and is serviced by specialist online peer to peer lending platforms.

    Both investors and borrowers must sign up for a P2P platform and the transaction takes place via the platform. The platform carries out all due diligence checks for all parties involved and determines a risk rating, which will then align with the level of risk an investor is willing to take.  

    P2P platforms make money by charging users a setup fee and tend to be paid by the borrower for reimbursement for services rendered i.e., the costs involved in finding investors and carrying out credit checks.

    Throughout the loan period, interest is charged and a percentage of that interest will go to the platform itself with the rest being paid to the investor.

    Currently, platforms do not have to disclose the margins they are taking, which makes it hard for both borrowers and lenders to compare different platforms, however, as P2P lending increases in popularity, the FCA is pushing for more transparency within the sector.

    Is peer to peer lending right for me?

    If you've been refused a loan elsewhere and you have an established trading history then peer to peer lending could be a great way of debt financing. However, before you proceed there are a few questions you should consider:

    Alternatives to peer to peer lending?

    We understand that raising capital is an important part of running a business, which is why we have a range of funding for businesses like yours.

    As an alternative lender to banks, we specialise in providing tailored financial solutions for SMEs. Offering fast, flexible and manageable terms, get in touch with us today and discover how Nucleus can help you.


    BY Jessica Lambert

    4 August, 2022

    4MIN

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