Peer-to-peer lending in 2020: Worth the risk?

Last updated: 31 December 2019

In 2019, three peer-to-peer platforms went into administration: Lendy, Collateral and FundingSecure. Two others (MoneyThing and BondMason) chose to go into an orderly wind-down, because they saw difficult conditions ahead.

These won’t be the last. There are currently somewhere around 70 peer-to-peer platforms in the UK, and a sizeable chunk of those won't make it through the next downturn. (That doesn’t mean they’ll all fail messily: there will be mergers, acquisitions and the sale of loan books to other institutions.)

Where does that leave you as an investor? Read on for my thoughts, and to find out what I'm doing personally.

The biggest risk in peer-to-peer

As I’ve said for years, “platform risk” should be by far the biggest concern for investors in this space. If a loan goes bad, you’ll normally recover at least some of your capital (as long as the loan is secured against an asset like property) and that one loan should only be a small part of your portfolio anyway. But if you have 50 loans on just one platform and the platform fails…no bueno.

Every platform is required to have a wind-down plan in place, where an outside company comes in to manage the orderly repayment of existing loans and return capital to investors. The platform is supposed to hold enough cash as reserves to pay the likely fees of the wind-down, but it's entirely possible that the eventual fees will be far higher than expected.

In Lendy’s administration (admittedly a messy one), the main insolvency practitioner has appointed eight (by my count) other firms to advise on specialist parts of the job. By the time they’ve all billed their chunky day rates, how much will be left over for investors? I’d guess not a lot.

So: Platform failures are inevitable, and investor losses in some of these situations are highly likely. What should investors do?

3 golden rules for peer-to-peer investing

Firstly, only invest money in peer-to-peer that you could afford to lose. If you have £85,000 in a bank account, you might only make 1.4% interest (the best instant-access rate I could find today) but you’re guaranteed to get it all back if the bank fails.

If you have £85,000 invested in the stock market, prices might fall by 50% (or more) but would likely recover eventually as long as you don’t have to sell. But if you had £85,000 in Lendy, you could have been making 12% interest for a couple of years but lose most of it (potentially all of it) when they fail.

If I lost all the money I have invested in peer-to-peer, I’d be very, very unhappy to put it mildly. It would be mentally extremely painful, and it would set back my investment goals. But it wouldn’t affect my family’s lifestyle. If you couldn’t handle the consequences – mental and practical – then don’t invest in this sector at all.

Secondly, pick platforms as well as you reasonably can. Don’t just chase the highest interest rates (which could in itself be a warning sign): look at their statistics, read reviews, and possibly even meet them if you’re going to be investing a large amount.

Thirdly, diversify – but not too much. Splitting your investment between different platforms means you’ll be less affected if one of them fails. But awkwardly, it also makes it more likely that you’ll end up being invested in one that does fail! I’m now invested in four platforms, all of whom I’ve either met face-to-face or have been reassured by their long (for the sector) and impressive track record. That feels about right to me, but it will be different for you.

To sum up:

  1. Only invest what you can afford to lose in peer-to-peer
  2. Diversify across a handful of platforms (and within as many loans as you can on those platforms)
  3. Don’t chase the highest returns: pick platforms based on track record, reviews and your own due diligence

I’m long-term positive about the sector, but under no illusions: every sector goes through a messy shake-out on its way to maturity, and this will be no different.

For me, the attraction of peer-to-peer is having investments with cash-like liquidity (under normal market conditions) while still beating inflation. I’m OK with the risks, and will be maintaining my own exposure at the same level during the next year. But make sure you go through the same thought process yourself, and come to your own decision.