Peer-to-peer lending: what you need to know

Peer-to-peer (P2P) websites work like marketplaces.

They bring together people or businesses that want to lend money with those that want a loan.

It’s a way for borrowers to get funding without going to the traditional sources of finance, such as banks and building societies.

On some websites, any money you lend out is automatically divided between lots of borrowers, but with others, you can choose who you’d like to lend your money to.

The interest rates on P2P lending are typically higher than those available from traditional savings accounts. Generally speaking, the higher the interest rate someone will pay, the higher the risk that they will be unable to repay the loan.

If you want to lend money, you should first compare P2P lenders and find one you feel comfortable with.

There are three main steps:

1. Open an account with a P2P lender and pay some money in by debit card or direct transfer.
2. Set the interest rate you’d like to receive or agree one of the rates that’s on offer.
3. Lend an amount of money for a fixed period of time – for example, three or five years. You might have to pay a fee to lend money (ie 1% of the loan).

Some lenders have an ‘autobid’ feature.

This means you can set limits on how much you want to lend each business and the lowest interest rate you’re prepared to lend at.

P2P lending can be risky for several reasons.

It’s useful to understand these risks and how they can be reduced.

The person or business you lend money to might not be able to pay it back (this is called ‘defaulting’).

The higher the default rate on a P2P website, the higher the number of people or businesses that are unable to repay their loans.

Unlike bank and building society savings, the money you lend via a P2P website is not covered by the Financial Services Compensation Scheme.

But a number of P2P websites have contingency or provision funds, which are designed to pay out if a borrower defaults on their loan.

These provision funds vary widely from one site to another, so it’s important to know what’s covered if you’re thinking of becoming a lender.

If your loan is repaid early or late, you could make less profit than you’d expected.

If a loan is repaid early, you can simply lend out the money again.

But there is a chance that you might not be able to lend out at the same interest rate.

You could lose money if the P2P company itself goes out of business (as several have done).

But if they are regulated by the Financial Conduct Authority (FCA) (as all P2P lenders operating in the UK must be), they must keep lenders’ money in ring-fenced accounts separate from their own.

Money earned through P2P lending is usually classed as income, which means it is taxable.

Most won’t pay any tax at all because of the personal savings allowance.

This allows basic rate taxpayers to earn up to £1,000 of tax-free interest. Higher rate taxpayers only have an allowance of £500.

Any interest earned above your allowance is paid at your highest marginal rate of tax.

An Innovative Finance ISA (IFISA) allows P2P loans to be held in an individual savings account (ISA). This means you can receive interest from P2P loans tax free and avoid being taxed on any capital gains (usually only applicable for very large investments).

An IFISA allows you to lend up to an overall limit of £20,000 per tax year (for 2024/25). The £20,000 allowance is shared between all types of ISA: IFISAs, Cash ISAs, Lifetime ISAs – which currently have a maximum annual allowance of £4,000 – and Stocks and Shares ISAs.

You won’t need to declare any ISA interest, income or capital gains to HM Revenue & Customs on any gains in an IFISA.

Before you lend through a P2P lender you should check that it’s regulated by the FCA. You can do this by searching for it on the FCA Register