I was reading recently that the UKs Financial Conduct Authority (FCA) has turned their attention to the peer-to-peer (P2P) lending market and it's likely they will be announcing new measures for the industry later in the year.

But what exactly is P2P lending? And is it something that you should be considering as an investment vehicle?

P2P Lending: The Billion Pound Alternative Investment Market

Although P2P has taken off in the UK in recent times, it’s actually been around for over 10 years. One of the biggest P2P providers in the UK, Zopa, set up shop back in 2005 and has lent more than £2 billion to borrowers so far.

The P2P lending industry in the UK as a whole pushed past the £7 billion mark in 2016 and is expected to grow to £16 billion by 2020.

It is therefore safe to say that this is not just the latest financial fad or hype. In fact, if you do your research, it can be a worthwhile investment option.

How does P2P lending work?

At its core, P2P lenders match savers (or investors) with borrowers through online platforms. This can either be individuals or small businesses.

It’s a hybrid option between saving and investing. It’s similar to saving with a bank (where you earn interest on your deposits) but unlike a traditional savings account, you run the risk of losing your money (i.e. similar to investing). 

The process is unique because it cuts out the need for traditional middlemen like banks and credit unions.

The biggest benefit to this is the more favourable rates both lenders and borrowers can enjoy. The interest you earn is also covered by the annual PSA (Personal Savings Allowance) and as of April 2016, you can put your P2P loans in an Ifisa to earn tax-free returns.

The downside? You are investing your money with individual borrowers and run the risk of potentially losing a big chunk of your money, if not all of it.

Different platforms manage risks in different ways. Some spread your investment into smaller portions across multiple loans while others offer a compensation fund. These compensation funds are not infinite though, and there’s no guarantee you will get your money back if borrowers default on the loans.

Some platforms offset the lack of a compensation fund with higher potential returns.

In most cases though, borrowers will be checked by a credit agency and will also have to pass the P2P lender’s own credit tests before they can apply for a loan.

And although the industry is now FCA regulated, it’s not covered by the Financial Services Compensation Scheme (which protects up £85,000 of your savings).

So, as with any traditional investing strategy, it all depends on the amount you are willing to invest coupled with the level of risk you are willing to accept.

What kind of returns can you expect?

There’s no doubt that record low interest rates in the last couple of years have pushed people to look at alternative investment options to beat rising inflation.

So what sort of returns can you expect from P2P lending?

If we look at the at the three biggest P2P platforms in the UK, Funding Circle, RateSetter and Zopa (also the founding members of the Peer-to-Peer Finance Association in the UK), you can expect anything between 2.5% and 6.5% p.a., depending on the length of time and level of risk connected to your investment.

Zopa requires a minimum investment of £1,000 and offers a projected return of 3.9% on its lower risk, Zopa Core product, and up to 6.1% on its Zopa Plus product.

Funding Circle requires a much lower minimum investment of £20 and has an all-time average annual return rate of 6.5%, while RateSetter offers anything from 2.5% to 4.8% p.a. on their Everyday account.

These are just a few of the big P2P lenders available in the UK but there are of course many more players in the market, offering different products depending on your investment needs.

Alternative global P2P lenders

In comparison to the UK’s £7 billion P2P market, the US P2P lending industry is the biggest in the world, with transaction volumes passing $21 billion in 2016. Big names across the pond include Prosper, LendingClub and Upstart.

LendingClub is the world’s largest P2P platform, and it’s evident through the range of interest rates on offer. Projected APR’s fall between 5.99% to a staggering 35.89% on long-term investments.

Upstart’s interest rates are just as varied, ranging from 4% to 26%, while Prosper offers a more down-to-earth 8.01% p.a. on average.

P2P lending is still splitting the field, with supporters championing the inflation-beating, potential returns and opposers warning against the unsecured nature of the investments. There’s no doubt however, that the industry is gaining momentum in the UK and globally. 

The old saying, “Never put all your eggs in one basket” holds true, but as part of a balanced investment option, it’s well worth considering. 

It’s a low-cost, low-barrier to entry, alternative investment option, which could provide the inflation-busting returns that turns a good investment, into a great investment.

Let me know in the comments or send me an email if have any P2P experiences you would like to share.