Defaulters might make peer to peer lending not such a rosy prospect

The recent rise in peer to peer lending websites and similar peer to business websites has seen some attractive interest rates being offered to lenders and easily available unsecured credit to borrowers.

However, the attraction may wear off fairly quickly if rules about taxation mean that lenders are not getting such a good deal when all the sums are done after all.

Peer to peer sites, like Zopa, offer much higher savings rates for lenders who are willing to risk their cash than the miserly savings rates presently on offer at standard financial institutions.

One can get more than 6% at present using one of these peer to peer sites, and even more if everything pans out well. The catch seems to be a real difference between the rates that are advertised by the peer to peer sites and what one actually gets after taxation and bad debts are taken into consideration.

Peer to peer sites work like an online broker between ordinary individuals who have spare cash to lend and other ordinary individuals who could do with the spare cash, but are either unable to get a loan from a standard institution or are unwilling to borrow from one of the more expensive short term loans providers like payday loans.

Lenders who lend to individual borrowers through one of these sites are taking a bit of a punt with their cash because the interest they received depends on the borrow actually paying the loan back and even then fees and tax can wipe out some of the gains.

Although one of the advantages of peer to peer sites is that potentially the average lender should get a better rate of interest than from a bank, because the website cuts out the profits made by the bank, the disadvantage is that the lender faces a loss if the borrower defaults.

According to Giles Andrews, who is one of Zopa’s co-founders, the method used to tax the interest received on a peer to peer deposit is “unfair”. This is because the tax is calculated on the interest after the website’s fee has been taken out, but before any decrease due to bad debts.

As the latter can be quite substantial, the lender might end up with considerably less than they thought they were going to get based on the advertised rate on the company websites. In some circumstances, when a lender lends money to higher risk borrowers bad debt may almost cancel all interest out of the loan and the lender ends up with hardly anything.