Frustrated savers are ditching high street providers and turning in rapidly growing numbers to online lending after watching cash returns plunge in recent months.
Peer-to-peer or social lending firms offering savings rates double those available from banks and building societies have reported surging demand as desperate savers look to escape the inflation trap.
The hunt is on for new ways of earning decent interest on cash deposits after fresh warnings that savers face at least two more years of below-inflation returns.
It was four years ago this week that the Bank of England slashed interest rates to 0.5 per cent, a move that has cost consumers some £220 billion in lost interest in the intervening period, according to the Save our Savers campaign.
The interest paid on savings accounts has plunged even further since August, when the launch of the bank’s funding for lending scheme (FLS) gave banks and building societies access to cheaper funding.
With a reduced need for cash deposits to finance their lending, banks and building societies quickly set about reducing their savings rates. The average interest on cash Isas has fallen from 2.5 to 1.8 per cent since August.
But high street savings accounts aren’t the only option open to cautious savers. Peer-to-peer lending websites are increasingly viewed as a viable alternative and will take a step closer to the mainstream when they come under formal regulation from next year.
These sites offer savers the chance to secure decent returns on their cash by providing loans to those in need of affordable finance.
January was a record month for peer-to-peer lending websites, according to the P2P Finance Association, with the two biggest players, RateSetter and Zopa, both reporting a spike in demand.
More than 10,000 lenders/savers have signed up to Zopa since September, a 152 per cent increase on the growth over the same period a year earlier.
Giles Andrews, chief executive of Zopa, said: “‘Banks have deserted savers entirely since the FLS started, offering them derisory interest rates, encouraging thousands of savers to look beyond the banks.”
Meanwhile, RateSetter facilitated almost £7 million of loans to individuals in January alone, a record increase.
Rhydian Lewis, founder of RateSetter, said: “A large proportion of our new customers are saying they have chosen to lend peer-to-peer because of interest rates nose diving since the launch of the FLS,” he said.
There’s been a similar trend at Funding Circle – which specialises in loans to fledgling businesses – which saw twice as many new lenders signing up last month as in December.
Samir Desai, founder of the firm, said: “Since the introduction of the FLS the number of investors signing up to Funding Circle has risen by 99 per cent. We know that over 80 per cent of our users choose us because of the great rate of return, currently an average of 6 per cent, in comparison to the banks”
If you’re new to the peer-to-peer concept, you’re probably wondering how it works and how risky it is. Here’s a brief guide to the sector:
• THE PREMISE
In a nutshell, the sites act as introducers that allow savers to earn money by lending to people in need of funds. The relatively low costs mean savers can earn gross returns starting at around 4 per cent and approaching double figures, depending on the borrower risk category they choose and the length of the loan.
• THE RETURNS
The average interest on Zopa varies according to the risk level chosen, although your money can be spread between different risk markets. The average person lending to risk level A borrowers – those with the cleanest credit records – earns 5.5 per cent (after charges and defaults). The return rises to 7.2 per cent if you lend to the B risk market. Charges are 1 per cent a year on the amount lent.
Savers using RateSetter have a choice of a four different accounts, from a monthly access account paying 1.9 per cent and a three-year income account paying 4.4 per cent to a five-year fix at 5.5 per cent. Savers pay a charge of 10 per cent of the interest they get.
Funding Circle lenders can get returns of almost 9 per cent before fees and tax, with the rate depending on the risk level selected. Like Zopa, it charges a 1 per cent annual fee on each of the loans outstanding, provided they are being repaid.
• THE RISKS
There’s no recourse to the Financial Ombudsman Service or the Financial Services Compensation Scheme (FSCS) if something goes wrong. Customers of one P2P firm, Quakle, were left nursing losses when it collapsed in 2011 after its bad debts spiralled out of control.
Andrew Hagger, personal finance expert at Moneycomms.co.uk, said: “One of the main concerns for people depositing their cash with peer-to-peer providers is that although the returns far outweigh those paid by the banks, they don’t offer the cast-iron guarantee to savers that bank customers enjoy under the FSCS.”
There are also concerns that as the P2P market becomes more competitive and the economy continues to flatline, the level of defaults could increase.
The criteria to which Hagger refers is the assessments to which borrowers are subjected. The rigorous checks – RateSetter and Zopa both claim to reject a sizeable majority of applicants – mean default levels are significantly below those of the high street banks.
Individual lenders are further protected by having their loans spread across multiple borrowers, to ensure they don’t suffer losses if one or two creditors are unable to repay.
At Zopa, for example, your money is distributed across at least 50 different borrowers if you lend £500 or more.
RateSetter also has an additional provision fund, a pot of money that grows with each loan matched. The fund is designed to guarantee that savers get all the capital and interest they are owed.
The main three P2P sites keep lenders’ money in ringfenced accounts. You should check which institutions are used, however, and make sure that any other money you hold with that institution doesn’t take you above the £85,000 deposit protection limit in the event of it going to the wall.
• ON BALANCE
The safest approach may be to spread your cash savings across different accounts, including Isas, fixed rate bonds, P2P loans and even crowdfunding ventures. That’s where P2P fits in – as part of a wider portfolio.
Hagger said: “The more established this market becomes, the more confidence consumers will have and if providers continue to keep rates competitive and bad debt levels at current low levels the peer-to-peer industry will become more widely accepted as a credible alternative to the banks.”
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