The peer-to-peer (P2P) lending sector has grown enormously in the last few years, with investments of up to £1bn completed by January 2014. Investors in P2P lending platforms can expect average interest of around 6% on their money, a more competitive return than the current 1-1.5% being offered by most banks on savings. Despite the high returns available, risk averse investors naturally want to know whether P2P is a safe investment. How exactly does it work and what are the risks involved?
How It Works
P2P lending platforms directly match individuals seeking to borrow funds with investors willing to lend. This cuts out the middleman – typically a bank or a similar financial institution – and its associated fees, allowing providers to offer lenders competitive returns on their investment and borrowers more efficient access to credit.
Wellesley & Co has a unique model and make loans in the first instance to borrowers. Wellesley then assigns these loans to lenders using the P2P platform while retaining a portion of every loan that it makes. It is the only P2P platform to risk its own capital in every loan that it makes, and in the event of a default Wellesley would lose all of its capital in a loan before any lender lost theirs.
Investing in P2P lending is not the same as opening a savings account and, like any investment opportunity, there is an element of risk involved. While the P2P sector is now under the regulatory umbrella of the Financial Conduct Authority, invested money is not protected under the Financial Services Compensation Scheme, which guarantees bank savings up to £85,000 per bank for each individual.
Provision Fund to Compensate for Losses
The principal risk involved with P2P lending is borrower default and to minimise this responsible providers screen potential borrowers according to strict lending criteria. Wellesley & Co. only considers loan applicants who can offer security in the form of a UK property which can be sold in the event of borrower default. In addition, the company has a provision fund of over £300,000 to compensate lenders in the event a borrower fails to repay their loan. Any investor who has suffered a loss of capital or interest can apply for compensation, although borrower default is typically low at around 1-2% across the P2P sector. Wellesley & Co uses an ‘Auto-Matching’ algorithm where on a weekly basis, lenders funds are re-allocated across the loan book, this increases a lenders’ diversification in order to minimise the effect of any loan defaulting.
With low default rates, increasing diversification, safeguards to protect client money and a provision fund to compensate for losses, investors should feel able to lend with confidence and look forward to bank-beating returns on their money. However, peer-to-peer lending is not suitable for everyone and would-be investors should consult a qualified and independent financial advisor to ensure it is right for their circumstances.