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Peer-to-peer lending explained

Money exchanging hands

Borrowing money from a stranger may seem odd but that’s the idea behind peer-to-peer lending, which allows you to borrow directly from other people.

Over the last few years, peer-to-peer lending has steadily improved and rates are slowly moving in line with the banks.

In fact, last month, Zopa launched a new low interest rate of 4.9 per cent for those looking to borrow between £7,500 and £15,000 over four or five years.

"Borrowers can now benefit from some of the lowest-rate personal loans in the UK," says Giles Andrews from Zopa.

"This will help create a more competitive market."

How does peer-to-peer rates compare to mainstream lenders?

This new loan rate from Zopa is very cheap, and drops even lower to just 4.8 per cent if you repay the loan over three years. 

"That's the lowest loan rate the market has ever seen," says Rachel Rawlings, personal finance expert at Confused.com.

To put this into context with mainstream lenders, on a loan of £10,000 over five years, Derbyshire Building Society and M&S Bank are both offering a rate of 5 per cent.

Meanwhile, Tesco Bank and Sainsbury's Bank both have a rate of 5.1 per cent.

"Internet providers can often offer lower rates as they don't need to maintain expensive high-street branches," says Rawlings. "These savings are then passed on to borrowers."

Elsewhere, RateSetter.com, the second biggest peer-to-peer lender for individuals, is offering a rate of 5.9 per cent on a £7,500 loan over three years.

How does Zopa work?

Zopa works by matching up borrowers and lenders directly.

The idea is that by bypassing the banks, both borrowers and lenders benefit from great rates without a mark-up on the deal.

In the last 12 months alone, the company has organised loans worth a hefty £107 million.

In a positive move for consumers, peer-to-peer lender Zopa offers borrowers the chance to carry out a "soft quote" search.

Benefits of peer-to-peer-lending

"This means you can check how likely you are to be accepted without affecting your credit report," says Rawlings.

"This is great for borrowers, as too many applications in a short period of time can damage your chances of being accepted."

In addition, if you are accepted by Zopa, you can pay the loan back early and make overpayments without having to face penalties or fees.

"This could potentially save you hundreds of pounds in interest," adds Rawlings.

Is peer-to-peer lending safe?

If you're borrowing via a peer-to-peer website, there are no risks involved.

However, savers who decide to lend through one of these sites do need to be slightly cautious.

This is because you do not get the same protection from the Financial Services Compensation Scheme (FSCS) as you would with a mainstream savings account.

Both Zopa and RateSetter do have their own provision funds in place to protect consumers.

Also, both are members of the P2P Finance Association, a self-regulatory body with a code of ractice.

In addition, from April next year, the government plans to introduce regulation of the industry.

Don't forget to shop around

While loans from peer-to-peer firms may seem tempting, it's still vital to compare rates across the market – making use of "soft searches" wherever possible.

"As well as the interest rate - the APR - there are a few things to consider when choosing your loan," says Rawlings.

"This includes how much you can afford each month, and whether you'll want to pay the loan off early.

"So think carefully and shop around to make sure you're getting the best deal for you."

Best rates reserved for those with clean credit records

You also need to be realistic about the actual rates you will be able to access according to your individual circumstances, as peer-to-peer lenders are not a soft touch.

"As you're borrowing from individuals – rather than a bank, Zopa will only consider applicants who have an excellent credit history," warns Rawlings.

"Put simply, if you want to be in with a chance of bagging a 'best buy' peer-to-peer loan rate, you'll still need to have a squeaky-clean credit record."  

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Esther Shaw

Esther Shaw

Esther Shaw is a regular contributor to Confused.com and is the former deputy money editor at The Independent and Independent on Sunday. Before that, she worked as a money and City reporter on The Daily Express and Sunday Express.
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