Readers of this column are savvy savers. I’d like to think that you would be able to tell the difference between interest on a savings account, and the interest payable on a loan. Yet I fear that peer-to-peer is blurring the boundaries.
If you have cash savings, the chances are you’re receiving a miserly rate of interest. Following a decade of rock-bottom interest rates, cash savers have lost an estimated £188bn, according to one estimate.
In September 2008, the average easy-access savings account paid interest of 3.08 per cent. Today, that figure has plummeted to 0.54 per cent. Since the Bank of England increased the base rate to 0.75 per cent last August, rates on some accounts have started to tick up — but the vast majority languish way below inflation.
There is more than £165bn on deposit in bank and building society accounts that pay no interest at all. Savers are looking for better returns.
Peer-to-peer lending may be a solution. It arrived in the UK in 2005, with online platforms such as Zopa creating a market connecting those who wanted to lend money with those who wanted to borrow.
As this week’s FT Money feature points out, regulators are concerned about how these accounts are being marketed and whether people fully understand the risks. The ability to hold peer-to-peer loans within an Isa (individual savings account) is part of the issue.
Peer-to-peer companies have been able to sell their investments as tax-free individual savings accounts since April 2016. Innovative Finance Isas (IFIsas) have attracted up to £1bn in the first two years.
This is where I fear people are in danger of confusing interest on a savings account with interest payable on a peer-to-peer loan.
To the untrained eye, the percentages featured on some advertisements appear to promise hefty rates of interest on cash savings. Some adverts go further, and reference the low rates on cash Isas, although the small print will point out that the higher rates reflect higher risks, and that your money is being lent out.
The peer-to-peer industry has been regulated by the Financial Conduct Authority since April 2014. However, because the investments are not counted as savings, they are not covered by the Financial Services Compensation Scheme, which provides up to £85,000 of protection per person if a savings institution fails. Your capital is at risk.
Those tempted by the high rates should also be aware there is no guarantee that the investor will get the target interest rate advertised by peer-to-peer platforms. Furthermore, to get the best rates, most platforms will expect investors to tie up their money for a fixed term of a few years or more, reducing flexibility.
Interest paid by the platforms is treated the same way for tax purposes as that paid by banks and building societies in that it qualifies for the personal savings allowance. This allows basic-rate taxpayers to receive £1,000 interest in a year without incurring tax; higher-rate taxpayers can receive £500 without incurring tax (there is no allowance for those on the additional rate).
With Isa season in full swing, older savers who have built a considerable degree of savings inside cash Isas may be tempted to transfer.
The peer-to-peer industry is alive to this — new investors are currently being offered incentives of up to £400 for investing in peer-to-peer accounts. To my mind, this is another marketing tactic more akin to a traditional bank account. But remember, this is not what you’re putting you’re money into.
Funding Circle makes regular offers of John Lewis e-gift cards to new investors. Those who invest more than £15,000 can get a £100 card, rising to £400 for those who invest £50,000 or more. Referring a friend can earn a £50 Amazon gift card.
RateSetter offers new investors a £50 bonus if they invest at least £500 for one year and a £150 bonus if they invest at least £10,000 for one year.
Investors should not be tempted to invest before a cut-off date or to stay invested longer than they intended to get a reward.
What investors do need to understand are the terms of the investments on offer and the risks they are undertaking to get higher returns.
Peer-to-peer platforms publish their expected loss rates alongside the target interest rates they expect to pay. They also provide the actual loss rates they experience. Typically, this is 4 per cent of loans.
Investors should be told the expected returns, net of fees and defaults and the circumstances under which the rate is achievable with details of fees and charges. They should also get an overview of where money will be lent and what checks are made on borrowers and how risks are calculated.
Finally, be aware that no interest is paid while your cash is waiting to be lent out. Investors do not accrue interest as soon as they pay over their lump sum as it takes time to match investors and borrowers. This is known as the cash drag.
The FCA is set to issue new rules for peer-to-peer lenders in the second quarter of 2019 to ensure that investors are fully informed. I await these with interest.
Lindsay Cook is the co-author of “Money Fight Club: Saving Money One Punch at a Time”, published by Harriman House. If you have a problem for the Money Mentor to look into, email firstname.lastname@example.org