In this low-interest rate and increasing inflation environment, all the investors are looking for options that can offer high returns to keep up with inflation. Alternative finance options are getting popular, and people are investing money in them instead of investing in traditional investments. Peer-to-peer lending is one of the most popular alternative investments offering high interest and many other benefits to investors and borrowers. It was established in the UK back in 2005 and has become popular rapidly due to its advantages and flexibilities. However, you must keep in mind that it is not free of risks. If you are a new investor and thinking of investing in p2p lending, you must want to know how it works.
To clarify all your confusion, we have put together all the information in this article. So read on to find your answers to get started with p2p investment.
Working Of P2p Lending
Peer to peer lending UK takes place through online platforms. All these platforms operate differently and have different rules. All the processes, from the way of lending to assessing borrowers and spreading investing to getting repayments, can vary from platform to platform. Several platforms are present in the UK offering p2p investment, so you must choose a platform carefully after doing research. Before making a final decision, you should read all the FAQs and reviews to understand how a platform works.
To start investing, you have to create an account as an investor and deposit funds, and the platform will do all the hard work to find borrowers, transfer funds, and receive repayments.
Generally, there are two ways in which you can manage your p2p investment.
You have complete control over your account and are in charge of managing it. You can choose the loans in which you want to invest money, depending on the information provided by the platform. However, it can be risky to select borrowers or loans unless you have experience in lending and have time to manage your portfolio.
- If you understand the risks and are ready to manage your portfolio, you should always spread your investment across multiple loans to reduce the risk of losing money. There are always chances of borrowers defaulting, so when you invest all your money in a single loan, there are more chances of losing money when a borrower fails to repay the loan amount.
- In the second case, you let your peer-to-peer lending platform do all the hard work for you. You can set your lending criteria, including your preferred interest rate, the amount of risk you are ready to take, and the time for which you want to invest money.
One thing that you should remember is usually the higher the risk, the higher the interest rate will be. When choosing the borrowers or interest rate, you must keep in mind your risk tolerance. Most p2p platforms display the interest rate, but the advertised rate is different from the one that you will receive. With the increasing trend of alternative finance, the government of the UK introduced IFISA (Innovative Finance ISA) to help investors maximize their returns. You can invest money in p2p loans through this ISA and earn tax-free interest.
How Risky Is P2p Lending?
The most significant risk of peer-to-peer investment is that your investment is not covered by the Financial Service Compensation Scheme (FSCS). When you invest money in banks or authorized financial institutions, this scheme covers up to £85,000 savings per individual. In addition, if any authorized financial institution collapses, your investment is saved up to a certain limit. However, if a p2p platform busts, you will not have such protection and can lose all your capital.
To provide some ease to the investors and reduce their fears, most peer-to-peer lending platforms display the number of default and successful loans. In addition, some platforms offer contingency funds to cover the losses due to defaults.
Despite high returns on investment, you should never forget or overlook that p2p investment is a risky undertaking. Therefore it is always better to keep these risks in mind and take necessary measures. To mitigate risks and get the most out of your investment.
Accessibility Of Funds
When you are investing money, you should always consider the liquidity and how easily you can withdraw your investment funds. Some platforms specify the amount of time for which you need to invest money, such as one year to 5 years. Others also specify the time after which you can start getting your interest rate. Therefore, you may not be able to withdraw your investment amount before the end of the loan terms. However, some platforms have a secondary market where. You can sell your loans if you are in need of money and want to . Withdraw your funds before the end of loan terms. In this case, you have to pay an early withdrawal fee. And also have to wait until you find a lender who is ready to take over your loans.
Is P2p Investment Interest Taxable?
Any interest you warm through p2p investment consideres income and is subject to UK tax. All the savings tax rules apply to this interest. And it is needed to be declared in your annual tax return. However, if you need a tax-free alternative, you can consider it through innovative finance ISA, also known as peer-to-peer ISA. It works in the same way as conventional p2p lending. You can use your annual allowance to make tax-free returns. And this way, you do not need to declare your ISA on your tax return. But if your returns exceed your annual allowance. You have to pay tax in the same way as your normal income.
We hope that now you understand the working of peer-to-peer lending. And make a better decision to invest in it or not. It can be an excellent addition to your investment portfolio to earn attractive returns. In addition, by taking accurate measures to mitigate risks and investing money in a good way, you can make it a source of passive income and enjoy the benefits of compounding interest by reinvesting.
