Peer-to-peer lending, or social banking, uses the principle of crowd-sourcing. Let's say you want to borrow a couple of grand to start an online T-shirt business.
Sign up to Zopa and you can get a loan at a very attractive rate of interest, plus a flat fee.
The money comes from a network of lenders, not a bank, and it pays to be a lender, too. At Zopa, for example, the average return at the time of writing is 5.0%, which is actually a lot better than most short-term savings accounts.
What if a borrower can't pay back the money? So far, Zopa has done pretty well on that front, with a paltry 0.28 per cent default rate. But your investment doesn't go to one person – it's seeded throughout the community at no more than £10 per borrower.
If one person defaults, it'll have little impact on your return as a lender. Zopa is the frontrunner in this area, but other sites offer a similar service.
You may get a better return from Funding Circle, for example. The main difference for borrowers is that there's no flat fee. Instead, a portion of the loan is paid to the service.
Funding Circle prefers business customers, while Zopa is open to anyone who has a good credit rating.
You can get a better return if you're willing to take a higher risk. That's how it works at FundingKnight.
Borrowers post loan requests and you can choose who you want to lend money to. You put in a bid for that loan, setting your own interest rate. The return on investments averages at 10.8 per cent, but although all borrowers are screened, it's somewhat riskier than lending to the crowd.
If a borrower defaults, a debt collector may called in to pursue your investment.
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