Peer to peer lending: is it a safe investment?

Peer to peer (P2P) lending is designed to cut out the middleman between savers and borrowers by offering a platform where people can lend to and borrow from each other directly (or semi-directly).

But is P2P lending safe? How much could you make or lose – and how great is the risk of not getting your money back?

We reveal the advantages and disadvantages of P2P lending.

What is peer to peer lending?

P2P lending lets people lend money to those who wish to borrow it without going through a bank.

This more direct approach allows lenders to earn a higher rate of interest and borrowers to pay a lower one, as a P2P platform has fewer overheads than a bank.

P2P lending doesn’t cut out the middleman completely. P2P platforms do a lot of heavy lifting, such as vetting borrowers, chasing repayments on lenders’ behalf and managing transactions, and for this, they take a cut of the money.

Financially it may work out better for both lenders and borrowers, but it's more risky for lenders.

How does peer to peer lending work?

There are fewer P2P platforms today than there were a few years ago, as several of the bigger names, such as Zopa, Ratesetter and Funding Circle, closed their doors to retail P2P lending, but there are still several specialist and property-backed platforms to choose from. 

As a lender, you’ll register with a chosen platform and pay in money using a debit card or direct transfer.

You’ll set or agree to a fixed interest rate and choose the period of time you’d like to lend the money (typically one to five years).

At the end of this term, once your loan has been repaid with interest, you can withdraw your cash or reinvest your profits to grow your money further.

Some sites let you select exactly who you’d like to lend money to. However, it’s more common for sites to divide your money between several borrowers to reduce your risk.

There are different products on offer, each with varying interest rates, risks and terms of withdrawal.

For example, you could invest £1,000 for two years at a fixed interest rate, with a 1% fee on total funds if you wish to access your cash early.

If you’re thinking of becoming a lender, it’s worth running through these options with a financial adviser so you know exactly what you’re getting into.

Is peer to peer lending safe?

P2P lending is also known as ‘investing in loans.’ Just like any form of investment, potentially securing a return from a P2P loan means taking some risk.

In the UK, every P2P platform is regulated by the Financial Conduct Authority (FCA). This protects lenders from malpractice by the provider, but it doesn’t protect you from losses or provider insolvency.

In 2019, the FCA introduced new regulations limiting new customers to P2P lending to only invest up to 10% of their investable assets if they have not received regulated financial advice.

The regulator also introduced further protections for consumers by making risk management practices more explicit, increasing the information provided to investors and their knowledge, and strengthening rules for what happens if a P2P firm fails.   

In a 2024 statement, the FCA set out its expectations for loan-based P2P lending platforms, which included them having adequate cash buffers to prevent consumer harm and stronger wind-down plans in case of business failure.

It also emphasised the need for lending platforms to make sure investors understand the risks of P2P lending, such as illiquid investments that are hard to sell, and the potential for losing money. 

Unlike banks or building societies, P2P lenders are not covered by the Financial Services Compensation Scheme (FSCS). If the platform goes bankrupt, your money could be lost altogether (though, as a creditor, you might receive something through the liquidation process).

Similarly, if the money you loaned is not paid back, you’re not protected by the government and may lose money.

Many of the bigger P2P platforms have a reserve fund to guard  against this, so that money can be repaid to lenders even if borrowers default.

However, these emergency funds are not bottomless and, in exceptional circumstances, such as a financial crisis or a ‘run’ on that platform, they might be exhausted.

In this scenario, you might lose out on your predicted returns or even lose your entire investment. The probability of this isn’t high, but it’s not zero.

Is it common for P2P borrowers to default on their loans?

Borrowers defaulting is one of the biggest risks with P2P lending, but thankfully, reputable companies plan for this outcome.

The major P2P lending platforms make an effort to be transparent, either giving each borrower a risk rating or factoring ‘bad debt’ (i.e. borrowers who might not pay) into projected returns.

You’re able to see this rating or risk category when investing so you can make an informed choice based on your risk tolerance.

Generally speaking, the higher the interest rate offered, the greater the financial risk.

What are the other risks of peer to peer lending?

With P2P lending, you make money based on the interest rate you set or agree to.

Typical interest rates can vary, depending on the risks you’re willing to take.

Even higher interest rates can be found, but again, this implies a much higher risk of losing your money.

In addition to the risk of losing money, the three other main risks of P2P lending are:

Risk of not getting your expected return

If a borrower repays your loan early or late, you could make less profit than anticipated. Your money also only starts earning interest once it has been lent out, not while it’s sitting in your P2P account waiting for borrowers.

It could take a few days to find a borrower or if you’re investing a lot, it could take longer for it all to be loaned out.

Risk of a P2P platform going out of business

It’s possible for P2P providers to fold. UK firms Lendy and FundingSecure collapsed in 2019, while The House Crowd failed in 2021.

P2P platforms are still relatively new and have yet to be tested by severe economic recessions or other significant market disruptions.

For this reason, the FCA requires P2P lending platforms to keep lenders’ money in ring-fenced accounts separate from their own.

It can be tricky to withdraw your money early

Many P2P lending platforms give you the option to withdraw money early. However, it might not be available to take out immediately, or you might be charged interest for doing so.

So, be sure to check the fine print carefully when making your choice.

What are the benefits of peer to peer lending?

For those willing to accept the risk, P2P lending can generate a good return and doesn’t require much effort, as the platforms do most of the admin and debt-chasing.

Additionally, money earned through P2P platforms is usually classed as income. That means it’s taxable, though most lenders won’t pay any tax thanks to the personal savings allowance.

With this allowance, basic rate taxpayers can earn up to £1,000 of tax-free interest per year (or £500 for higher rate taxpayers).

A financial adviser can help you understand your own individual tax circumstances and the implications of money made through P2P lending.

What are some examples of peer to peer loan companies?

There are several P2P lending platforms in the UK, including Kuflink and easyMoney.

Kuflink

Property lending platform Kuflink currently offers up to 9.13%, and you can allocate your money across multiple loans.

To note, this rate varies frequently, but typically, the rate is much higher than standard interest rates you could receive elsewhere. 

As these rates are very high, this is high risk, so you should do your research or consider financial advice before investing.

easyMoney

easyMoney offers rates of between 5.4% and 10% on property-backed loans, depending on how much you have to invest, with the highest rates allocated to investors with more money.

As with any investment, it’s worth getting financial advice or doing your research so you fully understand the risks.

How much should I put into peer to peer lending?

You can get started on a P2P lending platform for as little as £100, with no maximum limit. That said, the FCA in the UK has imposed a limit for first-time P2P lenders to protect them against default.

New investors cannot put more than 10% of their investable assets into a P2P lending platform unless they have had professional financial advice. Every P2P platform in the UK is FCA-regulated, so they must comply.

If you’re keen on becoming a P2P lender, it’s worth taking the venture on as part of a balanced portfolio of other investments so that you’re managing your risk.

Consider talking with a financial adviser to select a P2P investment amount suitable for your goals and risk appetite. But remember the golden rule: never put in more than you can afford to lose.

One of the biggest mistakes people make with P2P lending is treating it as a savings scheme (as it may superficially resemble one) instead of a medium-high risk investment.

What are the alternatives to peer to peer lending?

One alternative to direct P2P lending is the innovative finance ISA. You are still participating in  P2P lending, but your loans are held in an ISA tax wrapper so that you don’t pay income tax on the interest.

Another alternative to P2P, which works similarly, is to buy corporate bonds. These are also a form of loan to businesses, but may be lower (or higher) risk than P2P loans, depending on the company involved.

Get expert financial advice

Peer to peer lending could be an intriguing option for those looking to diversify their investment strategy and potentially earn higher returns.

However, it comes with risks, including the possibility of borrower defaults and platform failures. It’s essential to do your homework, consider your risk tolerance, and think about balancing P2P lending with other investments in your portfolio. Don’t invest any money you can’t afford to lose.

Let Unbiased quickly match you with a financial adviser for expert financial advice in assessing whether P2P lending aligns with your financial goals and risk tolerance.