Hidden costs of peer-to-peer lending

Rates you might get with peer to peer lending

Source: Investors Chronicle using providers' websites as at 17 November 2015.
Notes: *estimate of the annual return after fees and bad debts, **per annum interest rate, *** annualised projected return before tax, ****5 year average, pre tax, assumes reinvestment and no early repayment , † Weighted average interest after all costs and provisions for losses but before income tax,  † †Average annualised return after bad debt, before tax,  † † † average net return a year, ††††Past average rate annualised, after fees, before tax. Figures supplied by company.

What you pay

One of the advantages of peer-to-peer lending is that it is relatively cheap to invest. However, there is no set model for fee structures, so you will have to check each company. Some companies claim not to charge lenders anything, but there may be a servicing fee taken out of borrowers' repayments, so it is not totally free.

The fees are structured this way partly for tax reasons. Since 6 April 2015, personal taxpayers have no longer been able to offset lender fees or charges against interest earned under their loan contracts, and will need to declare the gross amount of interest arising during the tax year to HM Revenue & Customs.

Before 6 April Zopa charged lenders a 1 per cent annualised fee on the amount they lent to borrowers. This was accrued daily and deducted monthly. But as a result of the changes, since April it has stopped charging lenders up front. Instead a loan servicing fee, payable by borrowers, is deducted directly from each repayment before the principal and interest is passed on to lenders. This means that lenders will not be liable for extra tax.

"This change will not increase the cost to borrowers, or change their repayment obligations, since the interest rates offered by all lenders have always reflected their obligation to pay the annual lender fee," says Andrew Lawson, chief product officer at Zopa. "Nor will it reduce the net return to individual lenders, since the amount of the loan servicing fee deducted by us from each repayment will be the same as the annual lender fee."

A number of other providers have made similar changes.

Since 6 April Funding Circle no longer charges an annual investor fee, instead taking the same amount directly from the borrower repayments as a servicing fee. The company says that there is no change to the amount paid by borrowers or the amount received by investors.

Lending Works did away with all lender fees in anticipation of this ruling last April, meaning that there is no difference between the gross and net interest a lender receives. Before this it charged a 1 per cent fee to lenders, but this has now been transferred to borrowers who do not incur tax on it. Lending Works says the net effect to both the borrower and lender remain the same.

Ratesetter, meanwhile, has not charged lenders since May 2014, well before the changes preventing fees or charges being offset against interest earned. Before May 2014, Ratesetter investors were charged a 10 per cent fee on interest earned. RateSetter decided to make investing free to give investors the best possible deal, and make investing as transparent as possible, ahead of the change in offsetting rules.

Ratesetter says it did not increase its borrower fee to offset the scrapping of the lender fee and the net effect of the change was neutral. Rather Ratesetter's borrower fees vary according to the size of the loan, repayment term and the risk rating of the borrower. Borrowers are charged an administration fee plus a credit fee. There is nothing to pay upfront as all fees are added to the initial outstanding balance, with payment spread over the length of the loan.

Landbay does not charge lenders but rather charges borrowers upfront application and product fees of 2 to 2.5 per cent. It also takes a margin on the loan principal throughout the term, which is typically 0.50 per cent to 1 per cent a year of the total amount outstanding.

Lendinvest also does not charge lenders a fee. Borrowers have to pay arrangement, legal and valuation costs, which they can pay up front or in some cases add into their loan amount.

Madiston Lend£oanInvest does charge lenders fees, albeit at a very low level and a tiered rate. These are not charged until a lender wins a loan or bid, or has a match made, when a one-off flat fee of 2p is deducted from the lender's account. The company says this covers the site's costs of setting up the successful lending transaction account on the loan.

Thereafter it charges a tiered percentage fee per month on amounts over £10.

However, the company is now redesigning its site to accommodate a new charging structure. Instead of charging fees to lenders, there will be an administration fee paid by borrowers each month deducted before lenders receive the principal and interest that they are due. Madiston aims for this to be live in the next few months.  

Meanwhile, even if a servicing fee is not taken out of repayments, Nick Harding, chief executive officer of Lending Works, says lenders should check what interest rates borrowers are paying because if these are high it adds to the risk of the loans. "The rate of interest someone is willing to pay can indicate the situation they are in," he says. "It could mean a borrower is not credit worthy, which means their loan has a greater chance of going bad."