Lending Money on Zopa UK

Zopa is an Internet based peer-to-peer money lending website. Lenders can add money to their accounts of Zopa. Borrowers can then apply to borrow the lender's money, then repay it back plus interest. While this is similar to the way that most banks operate, the big difference is the control than lenders can exercise over who borrows money, and what interest rates the money is lent out at.

I'm based in the UK, so have made use of Zopa UK. There is also a Zopa operating in the USA, Italy and Japan.

Borrowers can borrow money through Zopa for a variety of reasons. Borrowing to purchase a car or to consolidate existing loans is by far the most common reason for borrowing money through Zopa.

Borrowers are classed into a number of risk groups based on age and credit score. Younger people generally have to pay higher interest rates for loans. Likewise, people with lower credit ratings will also pay much higher rates of interest. Zopa does have a sophisticated credit scoring system, and it only lends to people with reasonable or good credit ratings.

Most Zopa loans are granted on 36 month (3 year) or 60 month (5 year) terms. The interest rate is fixed for the duration of the loan. Interest rates are higher for longer term loans, as there is a higher probability of the longer term loan defaulting.

The Zopa website is well designed. It's easy to add funds to Zopa using a direct debit from a bank account. Zopa has a nice discussion forum and there is a great sense of community.

Once the funds have been added to Zopa, there are a number of ways to lend out money. The most common is to create a lending offer. It is possible to specify the required interest rate and the number of months that the money should be lent for.

By fine tuning the lending offers it is possible to specify which credit rating group the money should be lent to. Borrowers with lower credit ratings will pay the lenders a higher rate of interest, but there is a higher chance of the borrower not repaying the lender.

In order to spread risk, it is possible to split the funds so that only a small amount of money is lent out to each borrower. That way if a loan goes bad then only a small amount of money is lost.

I lent out a few hundred pounds in £10 chunks. The Zopa website provides a detailed breakdown of where each £10 is lent to, and what the purpose of the loan was. Obviously for privacy reasons it's not possible to learn too much about the borrower, other than their Zopa username and the town they live in.

Zopa also carries Listings. These allow borrowers to tell lenders more about themselves, and why they want to borrow money. Although it is nice to see that borrowers are actual people with real dreams and aspirations, lending through Listings is risky due to the higher than normal levels of defaults.

Before lending money through Zopa, I was very careful to read the small print.

The biggest problem is that Zopa isn't underwritten by the government. If Zopa were to go out of business, the lenders might not get their money back. In practice, should Zopa fail then it's more than likely that another company would step in to administer the loans. But it is a risk all the same.

Another issue is that UK taxpayers need to pay tax on the interest payments received by Zopa. These interest payments need to be declared on the Inland Revenue self assessment form. This form is long and complicated, and would be a lot of hassle for somebody to fill in if Zopa was their only source of untaxed income that needed to be declared. Furthermore, a higher rate tax payer would have to pay the current rate of 40% tax on their Zopa interest income. I would question why a higher rate taxpayer would even consider lending money through Zopa when it's possible to save tax free in a cash ISA or stocks and shares ISA.

A further problem is that money lent through Zopa is very illiquid. Once money is lent through Zopa then it's no longer accessible until the borrower repays the loan. As most Zopa loans are granted over a period of three or five years, that's a long time to tie up money. Occasionally borrowers will repay a loan early, but it's not a frequent occurrence. Consequently it only makes sense to loan money that isn't needed for several years.

I've now been lending money through Zopa for a year. I only lend money which I can afford to lose. So far I have made a few pounds in interest repayments, and a few loans have been repaid early. More disturbingly, there are a couple of late payment loans. Should these loans default then they would effectively wipe out the greater part of my profits from lending out to all my other borrowers.

I'm also wary of future interest rate rises. There is always a risk that should interest rates and/or inflation rise significantly then the loans made at lower interest rates will effectively become loss making. I guess this is why the credit crisis of 2008 ended with the bankrupcy of so many banks!

I now put any spare cash I have into a stocks and shares ISA. My Zopa money is being redirected into good quality corporate bond unit trusts. These are much more liquid investments. Returns are tax free and do not need to be mentioned on a self assessment form. And the risk level of default is probably the same as for Zopa borrowers. Zopa is nice for those who like to micro-manage their investments, but it wasn't for me.

See also other fixed income investments and more about lending money on Zopa.

Peer to Peer lending seems to be catching on. There's now an alternative to Zopa called Yes Secure.The site works in a similar way to Zopa, but the fees are slightly lower. Yes Secure also has a few other features, like the ability to lend via the site to friends and family. This is probably a terrible idea, but some people might like the idea of lending to people they know rather than to strangers.

Competition in the Peer to Peer lending market is great, so hopefully more competition will lead to lower fees for lenders.

If you're thinking of lending money via Yes Secure then remember that your funds are not guaranteed should the company fail like they are with a bank.

The author of this article is not authorised by the UK authorities to give financial advice. This article does not consitute financial advice. Before making investment decisions consult an independent financial advisor.