How to earn 6.00% on your savings
Savings rates have continued to slide in recent weeks, with deals being pulled left, right and centre and replaced with less attractive ones. Even the most handsome easy access accounts are now paying considerably less than 3.00%. And this already poor return is also likely to incorporate a 12-month bonus, after which time the rate will plummet even lower.
Part of the reason behind the rate falls is the effect of the government's Funding for Lending scheme, which has made more cash available to banks at a lower cost. This means they are now less reliant on retail deposits from savers, which reduces the need to offer them attractive rates. But, nevertheless, it's little wonder that savers are hitting back by seeking out more fruitful places for their cash.
Popularity of peer-to-peer lending
One option that is proving increasingly popular is 'peer-to-peer lending' (also known as social lending) where the money you invest is lent out directly to consumers, and sometimes small businesses. This negates the need for banks and building societies, and returns are typically much higher than you would find in the windows of either institution anyway.
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Zopa, RateSetter and Funding Circle are the most significant peer-to-peer websites in the UK – and all are undergoing a strong and steady growth as consumers turn their back on paltry savings rates and become more confident about the process of lending, rather than saving, in their quest for decent returns.
For example, Zopa, the first peer-to-peer lender which launched back in 2005, saw its busiest quarter ever in the three months to October with more than £240million being invested by savers and borrowed by consumers – making it 62% bigger than 12 months ago. "Things are booming," said Zopa spokesperson, Charlie Burgess. "People trust each other more than they trust banks and are realising that they can get much better deals on savings and on loans by cutting out the middle man and going to a peer-to-peer lender such as Zopa instead."
Rival, RateSetter, is also growing fast. Since launching in October 2010 it has doubled the size of its loan book every six months. The site's founder and chief executive, Rhydian Lewis, said: "For people asking why they should consider using peer-to-peer finance, the answer is that you get 2.5 times the average return on your savings." Interestingly, RateSetter also reported a 150% month-on-month growth in savers' funds during the first 10 days after the Barclays LIBOR scandal story broke, and people also lost even more faith in the high street banks.
Funding Circle, which launched in August 2010 to lend to businesses, rather than consumers, usually records around 100 new investors joining every six months. But, in September this year it saw a record month with savers' registrations increasing by more than six times compared to the same month the year before. To date, more than 700 businesses have benefitted from consumers' direct funds.
Spokesperson, David de Koning, said: "As high street savings rates have fallen yet again, people are becoming a lot savvier about where to keep their cash. They might not take it out of existing savings accounts but by the same token, they are more likely to be looking to peer-to-peer lending as a place for new cash."
Higher rates of return
Returns on all three of these peer-to-peer websites are almost certain to be higher than you would find on the high street – but bear in mind they may also not be as attractive as they first appear.
When you invest you will be charged a fee on your money – at Zopa, for example, this is 1% annually. You will also have to factor in 'bad debts' which is around a further 2% annually. But the 'gross yields' advertised on the sites do not take these deductions into account. In other words, they look more attractive than the Annual Equivalent Rates (AER) you see advertised by bank and building societies which denote the actual return in your pocket (albeit before tax).
Nevertheless, even once fees and bad debt have been stripped out and you are left with what is effectively an AER, peer-to-peer rates still trump those obtainable on the high street. Average returns at Zopa, for example, stand at 5.50% (as of October this year) once all expenses have been factored in, while at RateSetter average returns for investors range between 3.00% and 6.00% depending on the type of the account – for example whether the loan is paid back to you all at once, or monthly over a given time period. Funding Circle offers returns averaging 6.10% once all fees and bad debts have been factored in.
Risk and reward
But surely higher rates of return inherently bring with them more risk? In some ways this is true. After all, peer-to-peer lending sites are not covered by the Financial Services Compensation Scheme (FSCS) which protect the first £85,000 of your savings held per banking institution in the event it goes bust.
But peer-to-peer lenders have their own means of managing risk. This is usually achieved by divvying up the money you have invested into lots of small parts which is then spread over different borrowers – thus reducing your exposure to one individual.
For example, if your £1,000 is split between 50 borrowers of whom one or two defaults – you won't have lost much. And what you have lost should have been accounted for when calculating returns anyway, as mentioned above.
RateSetter, however, is different in that it guarantees to return every penny to investors by way of a Provision Fund which borrowers contribute to by way of a credit rate fee charged at between 0.5% and 3% of the loan.
In either case, acceptance criteria are set very high for applicants wanting to borrow through peer-to-peer sites with stringent credit, identity and income checks that see the vast majority rejected. At RateSetter, for example, 90% of consumer applicants are turned down, while Funding Circle will not lend to start-up businesses.
Time to change tack?
So long as you have done your homework and fully assessed the risks, there is nothing to stop savers with cash that's not doing much, from exploring peer-to-peer lending – after all loans start from as little as £20 and, once you've put a toe in the water, you could find there's plenty for the taking.
Please note: Any rates or deals mentioned in this article were available at the time of writing.