Peer-to-Peer lending—a whole new way of investing
Peer-to-Peer lending has become the poster child of the alternative finance industry. By the end of March 2016, the sector had attracted over £5 billion in investments. If the Peer-to-Peer phenomenon has escaped your attention, now might be just the right time to take note.
What is Peer-to-Peer lending
Peer-to-Peer lending is the now well-established practice of lending money to individuals or businesses through online services that match lenders, ie investors, directly with borrowers, enabling both parties to circumvent traditional providers such as banks.
Lenders (investors) typically achieve better rates of return than would be available from traditional providers. By the same token, borrowers gain access to flexible and competitively priced loans. Both consumers and SME (small to medium-sized enterprises) have found borrowing much harder to achieve since the banking crisis of 2008. Peer-to-Peer Lending helps them gain funding, and investors gain a better return in kind.
In short, it’s a win-win scenario for both parties, which is why peer-to-peer is confidently anticipated to become an ever-increasing force within the financial marketplace, even when interest rates begin to climb, given its significantly leaner cost base relative to traditional lending providers.
Peer-to-Peer lending companies operate almost entirely online, and so can provide services much more cheaply than traditional financial institutions, hence their ability to offer more attractive terms to lenders and borrowers alike.
A key attraction of Peer-to-Peer investments is their flexibility. Typically, you can choose to invest for growth, i.e. to roll up your returns and take them all on maturity at the expiry of your investment term, or take those returns regularly in the form of, say, a monthly ‘income’. It’s often possible to have those monthly payments paid regularly into a nominated bank account for added convenience.
Tax and returns
From 6th April 2016, through the introduction of the Personal Savings Allowance (PSA), savings accounts started paying interest tax-free and, as a result, an astonishing 95% of all UK adults no longer pay tax on any of their savings—it's the biggest shake-up in the savings market for at least a generation.
Previously, for every £100 of savings interest earned, a basic rate (20%) taxpayer would pay £20 in tax, and a higher rate (40%) taxpayer £40. Now, the new PSA means every basic rate taxpayer can earn £1,000 interest without paying tax on it; the allowance is £500 for higher rate taxpayers.
While additional rate (45%) taxpayers don’t receive a tax-free allowance at all, this concession therefore represents a very meaningful relaxation of the income tax rules for the vast majority of the UK population.
Peer-to-Peer vs traditional investment
Comparing Peer-to-Peer lending with deposit-based investment is relatively easy, but less so when comparing it to investing in the stock market. Shares, or equities as they’re often called, offer the potential for two types of return: an increase in the capital value of the shares themselves, as seen by an increase in the company’s share price, plus a regular—and ideally increasing—income by way of the dividends paid by that company.
Both can, of course, rise and fall in line with market conditions and the fortunes of the issuing business. What’s interesting to note, however, is that under the new PSA rules, dividend income from shares will not fall within your annual tax-free allowance and so they won’t enjoy the benefit of the favourable tax treatment afforded to investments such as peer-to-peer loans.
In future articles, we’ll be discussing some of the other interesting aspects of this revolutionary way of investing. But, if you’re still suffering from all-time low interest rates in your savings account, it really could be time to consider doing something interesting with your money.