Can peer-to-peer lending knock inflation out in round one?
Consumer prices in Britain rose by around 2.3% (year on year) in February. This is up from 1.8% in January, signalling the steepest monthly inflation increase since October 2012! What is to blame? Drivers include a juicy concoction of GBP weakness (since the EU referendum decision), higher transport costs and rising food prices (the first increase in 31 months).
Interesting stat: Egypt are currently running at 30.2% inflation. But hey, that would be like comparing apples and oranges.
The higher the inflation, the more prosperous the economy, right? Nooooo - as spoken about in a previous blog post (click here), the issue here is the eroding purchasing power of your money. Unless your cash is sitting in an inflation beating savings account, the cheddar growing mould underneath your mattress is becoming hazardous to both your financial and physical health (see what I did there...). How can we beat inflation using relatively unorthodox means? Most of us look at regular savings accounts, fixed savings accounts or the best current account offerings, however, what about peer-to-peer lending?
Peer-to-peer (P2P) aka crowd lending platforms are not a new concept, however, the average UK household still scratches their head as to what this phenomenon actually means. Here are 6 steps to lay the foundation of knowledge:
1. P2P websites appeared in the UK over 10 years ago, born to show banks the middle finger, whilst simultaneously matching individual borrowers and companies to lenders. The concept - by eliminating the banks from this process, facilitators like Funding Circle, Zopa and Rate Setter can provide you with a better deal. Landbay offer P2P with a twist, matching investors with borrowers, giving both parties exposure to the British housing market. The universal slogan - borrowers pay less vs a bank loan and lenders/investors/savers earn more interest vs a traditional savings account.
2. Now, many companies have boasted 7% rates for lenders - that really does knock inflation out in round one! However, there is no such thing as a free lunch and the risk-reward profile does not suit everyone. In all honesty, this is more like an investment product, with your savings NOT being covered by the Financial Services Compensation Scheme safety net (currently at £85,000). This normally protects consumers when financial services firms go belly up. Concerned about delinquent borrowers defaulting on their loans? On the bright side, these P2P pioneers perform in-house credit checks on wannabe borrowers and do all of the chasing for repayments on your behalf, making your due diligence a lot simpler. Since April 2014, the industry has been regulated by the Financial Conduct Authority, whilst by April 2017 all firms must have at least £50k in capital set aside to protect customers that have funds with them. Is that capital enough? Only time will tell.
3. Companies in this space offer a similar product, however, have a different DNA. Take Zopa for example - launched in 2005 and with a focus on individuals and households they reportedly have a default rate of less than 1%. Supposedly, the profile of their borrowers is usually home owners who have a yearly income of £30,000-£40,000. The cash is said to be used for home improvements, financing a new car purchase or debt consolidation. Even though the minimum investment for lenders is £10, Zopa recommend a £500 initial investment which is chopped up into mini micro-loans. The key here is diversification and not putting all of your eggs in one basket. To safeguard against this, Zopa only allow a max of 2% (of your total) to be lent to one borrower. Regardless of which platform you opt for, lending small amounts to many individuals/companies spreads the risk across the board, versus lending all of your cash to one potential bad egg.
4. The Personal Savings Allowance, why does this matter? This concept was discussed in a previous blog post of mine (click here) and in short it allows basic and higher rate tax payers to earn interest up to £1,000 and £500 respectively, tax-free! The interest you earn from peer-to-peer lending DOES count towards this and any interest earned above these thresholds, on a yearly basis, will be subject to tax. Speaking of interest - no interest is paid whilst cash is waiting to be lent out, so there is always the issue of opportunity cost.
5. When speaking to my millennial friends they had no idea an ‘innovate finance ISA' even existed. In a nutshell, you can include your P2P investments in your annual £15,240 ISA allowance (increasing to £20k from 6 April), along with your cash and stocks and shares ISAs. Shielding your investments from the tax-man sounds lovely, however, not all P2P platforms have received the FCA approval they need to provide us minions this benefit. So, read the fine print and do your research!
6. Using technology and copious amounts of big data, P2P firms are connecting borrowers with lenders (dressed up as investors), faster and arguably cheaper than ever. For those risk-loving individuals who don't mind locking away their cash for the medium to long-term (as this usually generates better returns), this could be for you. Even the mighty banks who claim to be unruffled by their online rivals want a piece of the pie - Metro Bank announced a partnership with Zopa in 2015! Nonetheless, global regulators and industry experts are scrutinising the infrastructure, robustness of credit checks and stress testing undertaken by existing and emerging web players.
**Jargon buster** - when I say stress testing, I simply mean envisaging worst case financial scenarios and calculating a borrowers’ ability to repay loans.
Many P2P companies offer single digit minimum investments, allowing you to build your confidence and knowledge of the sector gradually - testing the waters with a small investment could be the new source of fixed income you desired. Nonetheless, just like chocolate, such investments are only recommended within a balanced diet/portfolio.
The bottom line...
Realistically, knocking inflation out in round one is not an easy task and P2P lending is not for everyone. 2.3% already surpasses the Bank of England's 2% target, whilst UK households need to be equipped with a well-diversified and risk appropriate strategy. As discussed earlier, analysts have looked into their crystal ball and pre-empted an interest rate rise to curb inflation. As the UK enters a world of interest rate 'normalisation', whatever strategy you undertake, reinvesting interest earned can have serious compounding benefits in the long-term.
Click on the companies below to begin your search for the best peer-to-peer lenders for your risk appetite.
What do you think? Does P2P lending knockout inflation in round one for you? Leave your comments below.
Note: Your capital is at risk and speaking to an independent financial advisor is recommended.
Updated on 27 March 2017