What borrowers need to know about P2P loans

By Michael Lloyd

If you've been rejected for a loan or are just looking for an alternative source of borrowing than banks, you may want to consider P2P lending platforms such as Zopa, RateSetter or Lending Words.

The popularity of peer-to-peer (P2P) lending platforms skyrocketed between 2012 and 2015. P2P lending is the practice of loaning money to individuals without a traditional financial institution such as a bank.

According to a report from charity Nesta and the University of Cambridge, the UK P2P consumer lending market was worth an estimated £547 million in 2014, up from £127 million in 2012. P2P lending growth has been partly boosted by investors and savers turned off by low returns on traditional savings accounts since the Bank of England base rate was slashed to 0.5% in 2009. Tightened lending criteria among mainstream creditors after the credit crunch played a part, too. p2p-loans

If you choose to take out a P2P loan, here are five things you need to know:

1. How do they work?
According to Andrew Hagger, director of personal finance website MoneyComms, P2P lending platforms act as intermediaries between individuals or groups of investors who want to lend money, and consumers or small-business owners looking to borrow. The P2P platforms themselves don't actually lend any cash. They make money by charging borrowers an "introduction" fee and/or taking a commission from investors' returns.

"They are very lean online organisations operating with the very latest technology," Hagger said in an emailed response to questions.

2. Will you qualify for a P2P loan?
Like traditional lenders, P2P lending platforms use a combination of information from your credit file and the company's own lending criteria
when deciding who to approve. Investors may specify the types of borrowers they're willing to extend credit to, and are matched to would-be borrowers.

Some lenders opt to play it safe and lend only to applicants with good credit profiles. Others are willing to take a punt on riskier propositions in exchange for a higher interest rate. As such, you may want to consider a P2P loan if you've been turned down for credit elsewhere.

"If you apply for credit through a P2P lending platform, they are likely to check your credit history through a credit reference agency," James Jones, Experian head of consumer affairs, said in an emailed response to questions. "This will reveal how you've managed credit in the past and will, along with the information you've provided in your application, help them decide whether to lend to you and at what rates."

As with traditional loans, those with a good track record are more likely to get the best deals, Jones said.

3. What is the typical cost?
If you're approved for a loan from a P2P lender, your introduction fee and interest rate will depend on your personal circumstances. As with mainstream lenders, P2P platforms will typically ask riskier applicants to pay more.

However, if you have a good credit score and healthy finances, you can expect to be offered extremely competitive deals.

"The big two consumer P2P loan companies in the UK, Zopa and RateSetter, are very competitive with their lending rates, particularly for smaller amounts," Hagger said. "For a loan of £3,000, Zopa [typically] charges interest at 4% plus a borrowing fee of £60, making a representative APR of 5.3%. RateSetter charges interest at 3.2% plus an application fee of £85, which means a representative APR of 5.2% APR."

You'll also typically pay a fixed rate of interest for the life of your loan with a P2P lender, meaning you won't have to worry about price hikes.

4. Are P2P loans secure?
While investing money in P2P lending platforms can be high risk, borrowing from one is as safe as taking out a loan or credit card from a traditional lender. P2P lenders are authorised and regulated by the Financial Conduct Authority (FCA), meaning that their products have many of the same protections you'd enjoy from a traditional issuer.

5. Do P2P loans affect your credit file?
P2P lenders will report your loan activity to the credit reference agencies. If you fall behind on payments, the P2P lender will apply fees to your account. Essentially, you'll suffer the same consequences for paying a P2P loan late as you would with a mainstream loan or credit card.

"As with any credit agreement, if you miss repayments on a peer-to-peer loan, this is likely to negatively impact how lenders view you when you apply for credit in the future," Jones said. "Late and missed payments stay on your credit report for at least six years, so it's essential to make the agreed repayments on time each month."

See related: Don't let nontraditional loans lure you to debt, Guaranteeing a loan loaded with risk, responsibility

Published: 4 December 2015