Small but mighty: Online lending's growth market

Lenders and borrowers can get a better deal if they bypass the banks

THE frustration felt by savers at the paucity of returns being paid on cash deposits is neatly mirrored by that of borrowers struggling to secure personal loans.

So, nearly three years after the banking crisis began, it is no surprise that savers and borrowers are turning to each other in growing numbers for a solution to their problems.

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Until recently the notion of being able to lend and borrow to strangers online appealled only to an adventurous minority. But the social lending revolution is gathering pace, with several services now enabling borrowers and savers to cut out the middle man - the banking industry.

The services have flourished due to a combination of factors including the squeeze on household finances, the absence of inflation-beating savings products and the continued lending restrictions in the mortgage and personal loan markets.

Social lending or peer-to-peer websites allow savers to set the interest rate at which they want to lend, how much they lend, the return they want and the risk they are happy taking. In return, savers get interest rates significantly higher than from the average savings account.

Meanwhile, those seeking loans are offered more attractive terms than are typically available from the high street institutions.

Social lending in the UK kicked off with the emergence of Zopa. Individuals have lent more than 110 million since it launched in 2005 and more than 1,000 loans a month are currently being provided through the site.

But several competitors have emerged in the last year seeking to emulate Zopa's model, including RateSetter, Funding Circle and Yes-Secure. And Andrew Hagger, head of communications at, believes more launches are on the way as the appetite for peer-to-peer lending grows.

He said: "I think the distrust and bad feeling towards mainstream lenders will see peer-to-peer lending boom and see even more providers entering the market.

"However, they shouldn't be seen as a soft touch."

Hagger is referring to the strict lending criteria that most social lending sites apply in an effort to reassure lenders that their money is safe and not exposed to defaults.

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"If anything, the credit assessment process will be even more stringent than at traditional lenders, with the majority of applications being declined," he said.

Borrowers are subject to credit checks and those with high debt levels or impaired credit repayments records are typically rejected. Lenders on peer-to-peer sites are protected further by having their money spread across a number of different borrowers, so they aren't exposed in the event of one person defaulting.

But remember that while peer-to-peer lending sites are regulated by the Office of Fair Trading and recognised by the Finance and Leasing Association, they are not covered by the Financial Services Authority. That means savers don't enjoy the protection of the Financial Services Compensation Scheme, which guarantees savings in banks and building societies up to a total of 85,000.

Hagger said: "If you lend money through a peer-to-peer site, just be aware that you don't have this protection and that bad debts can impact the actual returns you receive.

"There are better returns to be made, but do your homework and understand the risks before committing your money to these schemes."

So how do the different services compare? Here's a brief guide to the main ones currently available.ZOPA

Savers can enter the amount they want to lend, the return they want and set the risk level of the typical borrowers they lend to. The riskier the borrower set, the higher the return, and vice versa.

For lenders, much depends on the credit record and the size of the loan required, as on the high street. Those with clean credit records can secure loans at significantly more favourable returns than offered by high street banks.

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Hagger said: "I got a quote on Zopa for a 3,000 loan over five years and it came out with an APR of 9.9 per cent - much cheaper than the nearest mainstream lender and compared with a market average of 19.1 per cent for a loan of this size.

"However, when I looked for a bigger loan of 7,500, the rate quoted was 8.9 per cent APR - higher than the market average of 8.6 per cent and well short of the 6.8 per cent best buy rate from Nationwide."

Borrowers pay a one-off 130 fee and lenders pay 1 per cent a year on the money they have loaned.


The new kid on the block was launched just last October but has already broken the 4 million lending barrier. Borrowers select the length of their loan - between one month and two years - and, as on Zopa, select from the different deals offered them. It accepts only between 12 per cent and 15 per cent of borrower applications and said it has yet to suffer a default.

RateSetter differs from other peer-to-peer lenders in that it holds a "provision fund" - a ring-fenced pot of money that increases with each loan matched. The aim is to ensure savers get all the capital and interest they are owed.

The average savings rate is currently 7.9 per cent (three-year fixed rate) or 3.8 per cent (variable, easy access). As for charges, borrowers pay a 115 fee, lenders pay 10 per cent of the interest income they get.


This is very similar to Zopa in both the way it looks and works. Where it differs is a community element - it asks members to invite friends and family to join the Yes-Secure social lending and borrowing network, with many lenders providing loans for people they know.

Loans can range from one to five years. Lenders are charged 0.9 per cent on the amount they lend, while borrowers are charged a flat 80 fee and penalised for any failed loan repayments.

www.yes-secure.comFUNDING CIRCLE

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This differs from the rest of the market in aiming at small businesses and start-ups struggling to get affordable loan terms. It allows savers to lend to businesses needing finance in return for an above-average interest rate. Loans are of one or three years and business borrowers pay lenders a fixed rate of return each month, with an interest rate on top of the repayment.

The higher risk inherent in lending to small start-ups in a difficult economic climate is the biggest concern for savers. But the loan is spread across different businesses and all borrowers need at least two years of audited accounts to qualify for a loan. Lenders can have no more than 5 per cent exposure to a single company. They can also inspect the accounts of prospective borrower firms and ask questions about how they will use the loan.

The average return is currently 8.3 per cent and depends on the risk level selected.

Hagger said: "Funding Circle is a relatively new operation and whilst it could prove a viable alternative to dabbling in the stock market, don't put all your eggs in one basket - perhaps test the water with an initial investment and see how it performs."