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Is Peer-to-Peer Lending Safe For Lenders?

The process of money lending has been very profitable for thousands of years, even before computers and credit reports.

There have been credit-reference agencies since the mid-1800s. From then onwards, it has become increasingly easy to assess borrowers and decide what interest rates to charge them.

In the early days of P2P lending, research from Liberum and data from Trading Economics showed that credit cards and personal loans in the US and the UK made money for banks every single year for 20 years.

They even made money during several recessions and property crashes that include the huge 2008 Great Recession. (It was crazy, complex and high-risk bank products that caused them all to lose money at that time, not their bread-and-butter lending.)

For 19 years now, money lending as an investment has opened up to ordinary people like you and me through peer-to-peer lending and similar online direct lending accounts, along with completely tax-free lending accounts called IFISAs.

Most of this lending is secured against property, meaning that, if a borrower struggles to repay, the properties can be taken and sold in order to remiburse lenders.

For the nearly two decades of its life, peer-to-peer lending industry has gone very well in the UK (and other developed countries).

Very few people have lost money overall and every single year being a positive year for lenders.

Indeed, lenders only earned less than inflation in one year during that entire time. That means only in one year was the interest lenders earned lower than the amount prices rose.

What you'll learn on this page

Why is P2P lending so stable?
How do the risks compare to savings accounts and the stock market?
“Lower risk” doesn't mean “no risk”.
Why the financial regulator needs to be cautious about P2P lending.
Why and how your money can get tied up for longer in P2P lending.
What is the safest way to do peer-to-peer lending?
Is there a higher-risk, higher-return way?

Why is P2P lending so stable?

Peer-to-peer lending has several characteristics that make it very stable as a form of investing:

Assessing a borrower is usually much easier than assessing how much a company is worth if you were instead deciding whether to buy shares. That makes setting borrower interest rates easier than deciding whether today's share price is good value.
You (or more normally the P2P lending providers) can very easily hedge against the risk of borrowers failing to pay by assessing lots of borrowers and spreading your money across them.
When you lend, you are higher in the queue to recover your money if things go wrong than when you invest in shares or a buy-to-let property. When you own shares or a buy-to-let, you are the first to lose your money when things go wrong, with your lenders getting their money before you recover anything.
In P2P lending, you usually lend from the start of the loan, meaning you pay exactly £100 for each £100 you lend. And you're targeted to get a calculated rate of return. In contrast, when investing in the stock market, or even the bond market, you usually buy second-hand off other people. This means that they might only sell to you for a higher price, increasing the risk that you won't make a decent return for it in the end.
When investing in shares and bonds, you usually exit by selling to others. Those others might insist on paying you less than you have got out of the investment. With P2P lending, you're not usually selling the loan to get out but rather the borrower pays you back at the end. Borrowers can't haggle over how much to pay you back, as it's in the loan contract!
In the UK at least, lenders and independent specialists such as 4thWay are provided with vast amounts of data and information, which makes it easier to assess the risks. Of course, share investors are too, but it's a lot easier to assess and verify lending data than it is to understand a company's business model, the viability of its growth plans, and interpret 30 pages of footnotes in published accounts.

How do the risks compare to savings accounts and the stock market?

You're far more likely to preserve and grow your wealth and savings with peer-to-peer lending than with savings accounts or cash ISAs.

Don't get us wrong: there are good reasons to save and use savings accounts. But it's virtually impossible for savers to protect their savings against the ravages of rising prices.

The stock market is also a fantastic investment when used in the right way and it's always going to be a very sensible investment for many people. But P2P lending returns are far less variable than the stock market.

Most stock-market investors lost money in 2014 and a heck of a lot of people lost money in 2008, and in many more years besides over the past 20 years. Even in pretty good years there are a lot of individuals and even fund managers losing money on shares.

In contrast, lending, including peer-to-peer lending, has been much more stable and consistent, through good times and bad.

Again, it won't always be as stable as it has been in the past. But lending directly to borrowers provides far less variable returns to investors.

Peer-to-peer lending generally sits in between savings accounts and the stock market. The majority of people lending their money through P2P can expect to become wealthier, earning far higher returns than savings accounts and cash ISAs, but with less risk than the stock market.

“Lower risk” doesn't mean “no risk”

But lower risk is not no risk! Some people will experience losses. In particular:

P2P lending will be subject to bubbles and crashes just like every other investment. While you can usually expect the volatility in lending money to be a lot less than the stock market, it is still important that you draw lines in the sand in advance to avoid being caught up in any euphoria and greed. (You can read more on this important risk in the article Greed and Fear in P2P Lending.)
A significant number of those who choose to go for the higher-risk peer-to-peer lending options, rather than the safer options, will lose a lot of money during crashes.
During extremely awful economic times – think as bad or worse than 2008-10 – even some of the safest P2P lending companies might not prevent every lender from making at least some temporary losses.
The P2P lending sites have widely varying standards, abilities and experience in lending, whereby some do not even conduct all the basic credit checks or other checks that you would expect or they do so with little skill. This means that the risks vary between them.

So the trick to safe lending is to educate yourself, and then keep your head and stick to sensible, safe lending strategies. Do this and you can expect to do just fine. Just like traditional banks used to do before they started offering mortgages to anyone who could sign a piece of paper!

Do check out The 13 Key Peer-To-Peer Lending Risks for more on properly identifying and containing the risks.

Why the regulator needs to be cautious about P2P lending

The financial regulator – the Financial Conduct Authority (FCA) – doesn't get praised when it permits ordinary people to invest in something that is new to them and it all goes well. That's just the minimum that people expect it to be capable of.

However, it gets absolutely vilified in the press, by the public and by politicians whenever there's a scandal.

As a result, it's therefore extremely cautious about new investments. Even after 19 years, it's cautious about P2P lending.

The stock market has been a much, much rockier road than P2P lending over this period. And far more tumultuous than ordinary bank lending in all the decades prior to that. (Again, learn about the full record in P2P Lending Beats The Stock Market, Yet Again, In 2023.)

And yet the regulator allows investment providers to sell share accounts with few barriers. Can you blame it? The stock market has been around for hundreds of years, so it can hardly introduce strict restrictions now. There would be uproar.

With P2P lending, on the other hand, the regulator still requires providers to plaster over many of their websites that the investments are “high risk”.

It also requires many providers to test many of their prospective lenders to ensure they know enough to lend sensibly while understanding the risks.

That might seem sensible, but since we don't do that for share investments, it leaves you with the absurd impression that money lending is riskier than shares, when it's demonstrably the absolute reverse.

You should note that it's not the FCA's job to assess investments, so it's unfair to expect any expertise from it in this direction. Its main goal – the one that suits it best – is to prevent scandals. The problem is that this goal doesn't always lead to balanced decisions, as it becomes more worried about preventing downside than allowing upside.

Why and how your money can get tied up for longer in P2P lending

What's more important: your money is safer or you have guaranteed instant access to your money?

When the FCA supervises investments, it puts huge emphasis on the potential for your money to get locked in for longer than you intended. This is called “liquidity risk”.

In peer-to-peer lending, at least a portion of your money can sometimes get locked in for many months or even some years. While you still earn interest during that period, it can be problematic for investors who didn't plan in advance for such an eventuality or who took needless risk tying up their money when they wanted to use in the near future.

And yet the risk of actually losing money is considerably lower than the stock market. It's often that liquidity risk is the flip side of the coin to stability. P2P lending is more stable in terms of far lower risk of losses, but the same features that make it safer also increase the chances you'll get tied in.

The good news is that, when this issue does occur, you're usually only tied in until the borrower repays you. Meaning you are unable to access any options to sell early.

While options to sell early usually work, it's highly probable you'll sometimes face longer lock-ins if you do P2P lending for long enough. It's par for the cause.

Once, again, you can read more about liquidity risk in The 13 Key Peer-To-Peer Lending Risks

What is the safest way to do peer-to-peer lending?

Perhaps you want to do peer-to-peer lending safe in the knowledge that you're taking the route with the lowest risk? There are some specialist P2P lending companies just for you.

The safest companies use at least a coupe of these risk-reducing techniques:

Lend your money to low risk borrowers only.
Allow you to spread your money across dozens or hundreds of borrowers. So you normally need an awful lot more than just bad luck to lose much money.
Your loans are secured against borrowers' properties, but not normally their own homes, which means the P2P lending company could force the sale of a property and pay you back if one of your borrowers can't pay.
A bad-debt provision fund: a pot of money set aside to pay you and other lenders back if one of your borrowers stops paying.
Insurance to cover your losses if a borrower is unable to repay due to unemployment or accident.

Perhaps most importantly of all, what all of the safer ones have is plenty of relevant experience from traditional banking, including a good dose of experience in the specific types of loans that the P2P lending company is specialising in.

This will include underwriting (that's the process they use to assess whether a loan application should be accepted) and it will usually also include credit-risk specialists (who model the risks and help design and improve loan-decision making).

Is there a higher-risk, higher-return way?

If you’re willing to take more risk, you can get far higher interest rates.

You can lend to payday loan borrowers, business start-ups or first-time property developers. You can also lend in a “junior” position, meaning that other lenders get repaid before you in the event the borrower struggles.

These loans will either go bad more often or will suffer greater losses when they do go wrong, and so you must expect much higher interest rates to make the risks more worthwhile.

However, all of us at 4thWay^® feel that the natural fit for most individual lenders is at the lower-risk end!