Maximising the benefits of peer-to-peer lending
The good news is that there are several ways to maximise the potential returns from P2P, which are typically between 5% and 9%.
Firstly, it is becoming easier to hold P2P loans in tax-efficient wrappers. For example, the Innovative Finance Isa, launched this April, allows savers to hold P2P loans tax-free, alongside a cash or stocks and shares Isa. This forms part of the annual £15,240 tax-free allowance.
Sadly the process hasn’t run as smoothly as many P2P lenders would have liked. Platforms must be authorised by the Financial Conduct Authority and approved as an Isa manager by HMRC before they can offer the Isa. This caused a surge of applications to the regulator, which resulted in delays, with many P2P platforms still awaiting approval. As a result, very few Innovative Finance Isas are currently available through P2P lenders.
However, many platforms are hoping to receive authorisation by the end of the year. Once this new type of ISA becomes established, it is likely to steadily find favour with income-hungry investors.
If you opt for an Isa provided by a platform you will only be able to lend via their own platform. In time, aggregator Innovative Finance Isas are expected to launch, which will give investors the option to diversify across platforms - although these are likely to carry additional fees.
Personal savings allowance
Investors can similarly maximise income from P2P loans through the new personal savings allowance, which enables basic-rate taxpayers to earn £1,000 of interest free of income tax. Higher rate taxpayers can claim up to £500 (there is no allowance for additional rate taxpayers). Think carefully about how best to allocate your income-focused investments between ISA and non-ISA wrappers to take advantage of this new allowance.
P2P loans can also be held in Sipps, which provide investors with tax benefits. However, just a few Sipps on the market are able to hold P2P loans, and due to the costs it is only viable if you have a large pension pot.
For example, the Evolution Sipp, offered by Sipp Club, can hold P2P loans across different platforms. Neil Faulkner, founder of P2P analyst 4th Way, calculates that higher rate taxpayers would need to lend a minimum of £100,000 to justify its £1,500 annual fee (plus VAT). This is based on an assumption of earning 5% interest per year from loans.
It is also prohibited to lend money to a “connected party”, such as your own business or a family member, through a Sipp.
In time, it is expected that cheaper Sipp options will become available, as competition grows and P2P becomes more mainstream.
Investors who are hoping to maximise returns from P2P loans should diversify across multiple platforms, gaining exposure to different types of loans.
Faulkner highlights selective property loans - available across platforms such as ThinCats and MoneyThing - as offering particularly attractive interest rates, between 7% and 13%. What’s more, these loans can be secured against properties with loan to value ratios of 50% and under. Property development loans are higher risk, so it is important to look at the underlying security.
Funding Circle, meanwhile, provides secured and unsecured loans to businesses, quoting an estimated return of 7.5% a year.
Diversification is key, so Faulkner advises holding property, consumer, and business loans across at least five platforms. If the loan is unsecured, make sure the platform focuses on high quality borrowers and if it is secured, look for a low loan-to-value ratio.
Angus Dent, chief executive officer of ArchOver a platform that specialises in P2P business lending, adds: “As with any service always shop around and make sure you understand what is offered, if there are grey areas, things you don’t quite understand move on. Chances are if you don’t you’ll be disappointed by the return.
“Whatever the level of security versus return you find acceptable, always build a portfolio. A portfolio on a particular platform and a portfolio across multiple platforms.”
Reinvesting the income earned from a P2P loan into new loans can help you to achieve a compounding effect. Many platforms allow you to do this by selecting the ‘auto-relend’ option. If you prefer to have full control, you can manually reinvest the cash.
- Part 1 of our brief guide to peer-to-peer lending, Five reasons to consider peer-to-peer lending
- Part 2 of our brief guide, Understanding the risks of peer-to-peer lending
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
Loan to value
The LTV shows how much of a property is being financed and is also a way to tell how much equity you have in a property. The higher the LTV ratio the greater the risk for the lender, so borrowers with small deposits or not much equity in the property will be charged higher interest rates than borrowers with large deposits. The LTV ratio is calculated by dividing the loan value by the property value and then multiplying by 100. For example, a £140,000 loan on a £200,000 property is a LTV of 70%.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.