Be your own lending bank

IN THE 1947 film, It’s a Wonderful Life, the hero George Bailey prevents a run on the Building and Loan by reminding his customers where their money is. “The money’s not here. Your money’s in Joe’s house, right next to yours, and in the Kennedy house, and Mrs Macklin’s house, and a hundred others” he cries, and miraculously, his depositors are convinced.

Few bank managers could do that now, but thanks to peer-to-peer lending, the personal aspect of saving is coming back. Instead of depositing money into a bank, companies like Zopa and Ratesetter let savers contract loans directly with a pool of borrowers, cutting out the middleman and offering much better rates in the process – the average interest rate earned by Zopa lenders last year was 8.1 per cent. Lenders choose how creditworthy they want their borrowers to be and earn an interest rate commensurate. Zopa recently passed the £100m lent mark, while Ratesetter has registered 3,327 new customers in little under a month.

According to Martin Campbell, a spokesman for Zopa, the social aspect is very important to making the business model work. “Our default rate is 0.7 per cent – which is much better than the average bank. We can get that because we turn down three quarters of people who apply for loans. Banks can’t so easily do that, because they come out looking bad, but because it’s not our money we’re lending out – it’s our customers – we can”, he says. He also adds that “anecdotally at least, when Zopa’s borrowers get into difficulty, their Zopa loans are the last they miss payments on: people are more willing to hurt banks than other people”.

So should you pour money into Zopa? Well, there is one catch. Though Zopa tends to pay higher interest rates, lenders also have to absorb bad debts. Unfortunately, those losses cannot be written off against tax, while income tax is payable on interest. As a result, some lenders – especially higher rate taxpayers – may find that the extra risk isn’t worth the return.

But another company, Ratesetter, is getting around that problem entirely by building a capital pot. Ratesetter, a social lending site that launched this September, is different from Zopa in that its customers do not have to pick a category of risk. Instead, people can put money into small loans and earn from 3.7 per cent to close to 8 per cent in interest a year, depending on how long they are willing to commit their money.

Rather like a bank, Ratesetter then charges an interest rate premium to riskier borrowers, which it puts aside to compensate for losses. According to Rhydian Lewis, the CEO, “The social aspect is good, but we’re not setting this up to be a charity – the point is to build a more efficient banking system”. Currently, the capital pot is worth 5.5 times the expected rate of default, so the company is not doing badly. But without FSA regulation or deposit protection, not all lenders will want to jump in straight away.

Peer to peer lending will never replace conventional banking – their much more restrictive borrowing criteria are certainly not for everyone, and part of the point of banking is to avoid risk. But with inflation at close to 5 per cent, and most conventional savings accounts offering less than 1 per cent in interest, now seems as good a time as ever to try social lending. As well as the chance of a better return, you will get the warm fuzzy feeling of funding Joe’s house. Or Dave’s car – apparently more Zopa borrowers are called David than anything else. That’s the sort of thing banks don’t tell you.

FAST FACTS | SOCIAL LENDING COMPANIES

Zopa: the first major British social lender.

Advantages:
Manage your level of risk from A* rated borrowers to Y (young) borrowers with no credit rating.

Get returns from 6.7 per cent to 12.2 per cent a year – depending on risk category.

Disadvantages:
You have to take the cost of any loans that go bad – and you can’t write it off against tax.

You have to commit your money for at least three years.

Ratesetter: A much newer social lending site.

Advantages:
No need to pick a risk category – all risk is pooled into a capital pot.

Get extra returns if the default rate falls.

You can lend money with a variable interest rate and withdraw it with one month’s notice.

Disadvantages:
Less overtly social – the business model isn’t that different from a conventional bank.

Smaller and less well established than Zopa – so potentially more of a risk.