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Income Investor: bypass banks for a decent return

Citywire's yield-hunting columnist, fed up with low interest rates on cash, overcomes his fears to try peer-to-peer lending.

 
Income Investor: bypass banks for a decent return

I keep a fair proportion of my portfolio in cash. One of my long-term savings bonds has matured, creating a familiar challenge: where to reinvest the cash?

Currently cash savings bonds do not look very attractive, with rates having slid down to around 3% for five-year bonds. With inflation at around 2.7%, this kind of account would be the financial equivalent of treading water. Cash ISAs are not much better – and, in any case, I prefer my annual allowance to invest in a Stocks & Shares ISA.

So, for the first time, I am stepping into the world of 'peer-to-peer' lending. This is a way of borrowing and lending money that bypasses the High Street banks – individuals lend to other individuals, with a company providing the framework for credit checks and collecting the repayments for you.

Novel approach

I have looked at peer-to-peer lending before and filed it away as 'too risky/too unreliable'. However, I like the novel approach that RateSetter takes. Other lenders tell you to expect a small amount of bad debts or late payments. However, RateSetter has instead put in place a Provision Fund which is intended to deal with the infrequent incidents of non-payment. Although they point out that this does not amount to a guarantee, as such, they note that every lender has – so far (according to them) – received what they were expecting, in terms of interest and return of capital.

It is worth stressing that this use of your hard-earned cash is not guaranteed by any government scheme, although the companies involved are regulated. After all, no-one can force the borrowers to repay the money they borrow, effectively with a contract with you.

Having said that, the RateSetter website is very easy to navigate and the on-line activity is surprisingly transparent. Lenders choose their target interest rate and lending period (up to 5 years) and the amount they want to offer. They then join a queue of lenders at that rate and wait for the software to match up the money available with the stream of lenders looking for a loan (typically for buying a car) – you can watch the process in (almost) real time. You can also elect to have this money automatically re-lent at the future current 'market rate' or have it returned to your 'holding account'.

It is easy and quick to register and transfer cash (with a debit card, for your first three deposits) and I was up and lending in a day. There is even a function to withdraw interest at regular intervals to give you an income.

No quick cash

As with savings bonds, you normally would not have access to your capital over this time – although it is possible to get it back at the cost of lower interest payments (which would defeats the object of trying to get better returns). So make sure that you won't need the money for the period you tie it up.

The prevailing interest rate is set by demand and supply. Currently the 5-year interest rate is hovering around 5.6 to 5.8%, much higher than available in any ordinary savings bonds or even Cash ISAs. But this return carries risk, so I am only investing a limited portion of my cash savings.

Of course, any income earned this way is liable to income tax, so you should consider your overall tax position. If you are a taxpayer, this sort of return is available for many securities in a Stocks & Shares ISA – tax-free.

If you've enjoyed this article, why not visit DIY Income Investor's blog? The views in this article are the author's own and do not constitute advice.

18 comments so far. Why not have your say?

Clive B

Mar 12, 2013 at 10:18

I used to have some money in Funding Circle. Found 2 main problems, a) the bad debt rate was higher than I expected given the relatively modest lending rates, and b) any money you make is subject to income tax (rather than CGT) and you can't count losses against your tax bill, or have it inside an ISA

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Vague Shot

Mar 12, 2013 at 16:10

I've been a Zopa investor for nearly six years. The bad debt rate has been small and if I knock it off the interest I've received, I'm still getting well upwards of 4 to 5% before tax, although it has dropped a bit in the last six months or so. But that's probably because there have been a lot of new investors forcing the rates down.

One interesting point, is that I've now taken over a hundred loans off other lenders, through Zopa's get out system called Rapid Return. None of those has left me with any debts, so far!

I am also an investor in Funding Circle and Ratesetter, but prefer Zopa, as the interface is much simpler.

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Clive B

Mar 12, 2013 at 16:31

Vague Shot

"I'm still getting well upwards of 4 to 5% before tax"

For 40% tax payers, that would be around 3% after tax. Not enough for me !

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nickle

Mar 12, 2013 at 16:35

The problem is that like increases in capital requirements, peer to peer lending is going to screw the ecomony.

For each pound P2P lent, another 8 pounds worth of loans will be pulled.

For peer to peer investments, its completely different.

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Vague Shot

Mar 12, 2013 at 16:41

I did say well upwards. I'm happy with the return and i do think that the next phase of peer to peer will be better and more rewarding all round.

It's also worth looking at what the University of Huddersfield is doing with Funding Circle.

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Clive B

Mar 12, 2013 at 16:48

Vague Shot

I'm not knocking you, or others who find lending profitable, either monetarily or for the social good. The latter was part of the reason I got into it, but I found I wa getting around 10% tax free on a corporate bond fund unit trust, whereas I couldn't see myself ever getting that from P2P. Hence, I left.

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Andrew Barwick

Mar 12, 2013 at 16:48

Like VS above, I have been experimenting with Ratesetter, Zopa and Funding Circle for the last six months or so. The rates on Ratesetter don't seem worth the bother unless you go long term.

Zopa may turn out OK but it is too early to report on bad debts.

I like Funding Circle because the rates are higher and borrowers are companies and you can check them out to some extent , however I have noticed that the blurb from FC is all about increases in their lending, whereas information on how bad debts are trending is not available, so I have lent money based on their credit judgement but am unable to measure how good their judgement is, nor can you pick up whether bad debts are increasing because they don't release enough current information.

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Evaluator 1

Mar 12, 2013 at 19:14

No comment on "Thincats" yet. This is the real deal, go and check the website at Thincats.com. No mom and pop bids though.

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Peter Horrocks

Mar 12, 2013 at 21:08

I invested a nominal sum in Zopa (£1500) in June 2009 and reinvested all payments for a 2year period. The majority was spread among the A & B customers( Low Risk) Low returns ,and the remainder among C and younger clients higher returns.By the end of 2011 bad debt and late payments started to rise so I started to withdraw money. I have now managed to withdraw £1593..........but this is the reality;

Interest over 3.5 years =£306

Less 20% Tax - £61 =£239

Less annual lender fee - £33 =£206

Less Bad debt -£47 =£159 over 3.5 years = 3%

and this doesn't take into account a further £38 late payments which are the next batch of bad debts!........Just a thought for all you peer lending enthusiasts.....Its been an interesting but far from profitable ride.

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Russ King

Mar 12, 2013 at 23:17

Useful to hear from other investors. I have only just joined Zopa and Funding Circle but looking at blogs on their website it would seem that some investors are really angry and others are really happy, no in-betweeners.

I am not looking to put much in until I have started to see some proper returns.

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SimonM

Mar 13, 2013 at 00:13

I've been lending through Zopa for 2 1/2 years - eventually settled on drip feeding a £50/week in, and re-investing all returns, building up to £6.5k. Approx 1100 loans of £10 each. The good news - the vast majority of borrowers repay on time and about 200 of mine have repaid early as Zopa allows. For my chosen markets, borrowers often repay for about 12 months before they miss repayments, so more than a 1/3 of the loan is returned, Zopa has written off one as a bad debt, and I think 2-3 may go that way.

Having said that, I've been withdrawing the money for a few months now. When I started, rates were good enough to make a return, but 1. Zopa removed the separate Under 25 market (which I found had a high return and no repayment problems), 2. Interest rates have dropped in line with general market rates and 3. despite this, Zopa still takes a fixed 1% cut off the interest return. Could accept this when the gross return was 7-9%, but not at 5.6%.

As Peter Horrocks has demonstrated, at these rates once you deduct Zopa charges and tax, the marginal return doesn't justify the extra risk.

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Clive B

Mar 13, 2013 at 17:20

Evaluator 1

With a £1,000 minimum bid, I think I'll stay clear of Thin Cats - take too much money to get a diversified loan book (e.g. £50K for 50 loans)

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MOGO

Mar 15, 2013 at 10:05

I put £1000 into ZOPA 2 years ago, as a trial, return has been modest at about 5% net., so far only 1 late payment of £10. Return is ok but nothing to get excited about so I am in no rush to exit but unlikely to put more cash in.

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batman1

Mar 16, 2013 at 11:39

Take a look at Platformblack.com, annual returns of over 12% are achieved. Like Thincats they focus on Business to business funding.

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malcolm roberts

Mar 17, 2013 at 10:11

I invested £50k on a five year plan which gives me an income of £200 per month, the only drawback is the capital is tied to property and no access for five years.

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snoekie

Mar 17, 2013 at 21:43

No thanks, and I thought the market risky.

Yes, I have had some losses, but decent capital growth, which you will not get on loans. Litigation costs are high, and Judges do triple somersaults to molly coddle the debtor, maye a shilling a year for some of them, and you will have to survive to 500 to recover, and still lose a hefty chunk on costs.

As for bonds, a risky proposition, my take.. Mind you the recent rise is unsustainable, and a correction, perhaps 20% will, IMHO, follow. But then I am no oracle.

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invsb

Mar 17, 2013 at 21:58

From what I understand, the interest you earn from all these sites is paid gross. Do you then have to fill in a tax return to pay your tax to the revenue? Thanks.

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Clive B

Mar 18, 2013 at 11:01

invsb

I've lent money on Funding Circle and yes the interest is paid gross, so you have to declare it to HMRC.

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