2015: Great Returns on Peer-to-Peer Lending

By Matthew Howard on 31st December, 2014 | Read more by this author

Now is a very attractive time for peer-to-peer lending with interest rates well above where they should be for the risks involved.

Why is 2015 such a good year?

While borrowers are being quick to get on board for the lower rates and better terms, lenders, on the other hand, are being slower to accept peer-to-peer lending.

This means there is less competition. If there were lots of lenders fighting to lend, it would push interest rates down.

Here’s how it works. Say you have borrowers who collectively want to borrow £1 million today. If you have lenders who collectively want to lend £1.1 million, most of them can take part at a great interest rate.

However, if there was, say, £10 million-worth of money that lenders desperately wanted to lend – and still borrowers just wanted £1 million – this would push interest rates right down. Many of those lenders would be willing to accept a lower interest rate just so that they can get their money lent out. Those who are willing to accept the lowest rates will get to lend their money.

Note that this effect of supply-and-demand affects all peer-to-peer lending companies, regardless of how they operate or how safe or risky they are.

Why aren't their more lenders?

Lenders are still cautious about P2P. If you’re cautious, you demand a higher interest rate before you’re willing to lend.

In addition, the industry is still relatively new and unknown. We lent £1 billion in 2014, but this is nothing compared to the billions sitting in savings accounts (paying almost nothing back) or in the stock market or property.

So, overall, interest rates are higher than they deserve to be for the relatively low risks involved.

This effect is stronger with newer lending opportunities. Lenders are very slow to trust new peer-to-peer lending companies even when they’ve already built up solid records over ten to 12 months. These companies have often proven that they’re not reckless – often quite the reverse – but lenders remain overly cautious, in our view.

Good examples are Lending Works, FundingSecure – and even oldie Funding Circle if you consider its A+ market. But really you can currently find great opportunities all over the shop. Each offers you interest above 6%, sometimes well above, after fees and expected bad debts, but before taxes.

Why should rewards match risks?

Over the long run, on average, investors (and lenders) get back higher rewards the more risk they take. This is always true regardless of what the opportunity is.

On average is a critical phrase there. The riskier something is, the more variable the returns. This means that some might make much more than average while others lose everything.

We can strongly expect that savings accounts will always pay out less than peer-to-peer lending companies. And we can expect that, in the long run, the stock market will do better too, at least before you deduct your investing costs – but it's not doing all that well against P2P at the moment.

This is because ultimately stock-market investors will be more willing to buy shares when prices are low enough for the larger risks involved. Savers will generally be willing to earn nothing on their savings because at least they're not going to lose a load of money in a crash. And lenders will only lend if they can get an interest rate that is high enough to justify the extra risk of saving over and above savings accounts.

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