Social lending cuts out the banks Poor savings rates and a growing mistrust of high street lenders are prompting more consumers to bypass banks and do business with one another via peer-to-peer (P2P) websites. RateSetter.com, an online company which enables savers to earn higher interest rates by lending to other people than they can from a high street bank, has reported a rise in the number of new users in July so far, compared with previous months. Peer to peer companies have thrived in the past couple of years in the UK as consumer disillusionment with traditional providers spreads. The sites put savers searching for decent cash returns in touch with borrowers looking for competitive loan rates. "Many people doubted whether peer-to-peer lending would ever really take off, however it appears that the sector is going from strength to strength and is increasingly accepted as a credible alternative to the banks," says Andrew Hagger of personal finance website Moneynet. A lack of confidence in the UK banking sector since the credit crisis, combined with high borrowing rates and low savings returns, has helped the P2P market flourish, with new providers entering the industry in the past couple of years. Compared with mainstream banking this new breed of finance is still in its infancy. Zopa, the UK's first peer-to-peer lender which has arranged loans of more than £190m, celebrated its seventh birthday this year. But as the sector expands it is starting to offer lenders and borrowers greater choice. This week a new site, Squirrl.com, was launched, allowing lenders to invest in secured loans made to established companies, rather than start-ups. Another new offer, Seedrs.com, lets small investors invest in new businesses with a minimum investment of just £10 per business, allowing users to spread their investment risk across a number of companies. In the currency transfer market two new entrants - CurrencyFair and TransferWise - have taken a different approach to the P2P model. The two sites operate as online currency exchange businesses in which users can get the best rates for transferring money into other currencies, rather than lending out money. The biggest caveat to all these sites, say experts, is that they are not risk-free. Savers are not covered by the Financial Service Compensation Scheme, which protects up to £85,000 in customers" funds held in a single financial institution if it fails. If however, a borrower who uses the P2P site defaults, those lending to them will be left out of pocket. In order to improve the situation some of the largest P2P companies: Zopa, Funding Circle and RateSetter, have formed the Peer2Peer Finance Association, a UK trade body set up to ensure that the sector maintains high minimum standards of protection for consumers and small business customers. Hagger notes that RateSetter recently stated that only 10-15 per cent of loan applications are approved, so while it may offer a simpler and fairer way to borrow money, anyone without an excellent credit profile will have to seek finance elsewhere. "Even though tough credit scoring criteria is in place, there is still an element of risk, albeit small, that you don't have with a bank or building society," says Hagger. As long as you are comfortable with this, you can obtain better returns on your cash in the P2P market, as they do not have the overheads of running a nationwide network of branches. Some providers have put in place their own methods of mitigating risks for depositors. Zopa, for example, will spread money invested across a wide range of borrowers. RateSetter adopts a different approach by operating a "provision fund," which is built up from borrower fees, and reimburses lenders in the case of late payment or default. Thin Cats ThinCats.com facilitates lending between individuals and small businesses. The loans are secured, which means they are less risky, though the minimum investment is larger. The smallest bid per person per company is £1,000 so this is a site that is aimed at more experienced investors. Businesses seeking funding pay a £450 to upload their information on to the website. Potential lenders participate in an auction to lend to that company, set the interest rate and the amount and a syndicate is then made up of those bidders offering the lowest rates. Average rates tend to be between 8-11 per cent. Lenders are not charged a fee and ThinCats will chase outstanding payments. Investors who don't have time to assess the risk profile of each borrower themselves have the option of investing in the ThinCats" Bond for Business. The bond uses fund manager Innvotec to invest in a portfolio of small business loans. Minimum investment in the loan fund is £5,000. Zopa Zopa puts savers in touch contact with people who need to borrow. Individuals enter the loan amount they want and the length of the repayment term and see the rates available on the site's market. Once you apply for the loan and Zopa has your credit score, you will be categorised under a risk rating that dictates the deal you will be offered. Although Zopa takes a one per cent fee for arranging this service it does not hold the money itself, so doesn't need to build extensive reserves to cover bad debts. This means the rates on offer are attractive - over the past year lenders have earned about 5.5 per cent on their money, and this is after charges and defaults have been taken into account. At the highest end of the risk scale lenders can earn more than 9 per cent. There is a choice of five categories of borrower to lend money to, ranging from A* (low risk) to C (high risk) and those aged under 25 ("Y"). Funding Circle Funding Circle works in a similar way to Zopa, although money is lent to small businesses, so it is more peer-to-business than peer-to-peer. Investors can either choose the businesses they want to lend to, or use an "autobid" process, which means their money is spread across a range of businesses in £20 units according to the rate of interest they are prepared to accept. Borrowers are categorised into bands according to their likelihood of being able to meet repayments. The loan terms are of one or three years and business borrowers pay lenders a fixed rate of return each month, with an interest rate on top of the repayment. The average return is currently around 8 per cent, although it varies with the risk level selected. Lenders who use Funding Circle are charged a 1 per cent annual "servicing fee." RateSetter To get a loan through RateSetter you must be aged at least 24, have a good credit history and a regular income. Individuals can borrow from £1,500 and the average loan is currently around £4,000. The rate offered to borrowers will depend on how much they want, the repayment term and an assessment of the credit risk. The average repayment rate on a loan of £5,000 over three years is 10 per cent. Andrew Hagger at comparison service Moneynet says that savers can earn 4.7 per cent on a fixed-rate bond option from Ratesetter. On £2,000 savers will earn £84 and on £10,0000, £470. Lenders are charged 10 per cent of the interest paid, while for borrowers there is a fixed fee on completion and a credit fee, which varies depending on the individual's credit rating. Seedrs A different take on P2P finance, Seedrs enables investors to back start-up businesses from as little as £10. Regulated by the Financial Services Authority, it enables investors to invest in fledgling businesses while enjoying big tax breaks. Most start-ups offered on Seedrs will allow investors to claim the generous "Seed Enterprise Investment Scheme" tax relief that the government recently introduced to encourage investment in young businesses. The relief allows investors to claim back up to 50 per cent of the money they invest in eligible start-ups, up to £150,000, as a reduction in the income tax paid in that year. One of the first companies to seek funding via Seedrs is Digital Spin, a company that wants to raise £60,000 for work it is doing in the field of "captchas" - the system that websites use to detect spam email. Squirrl Squirrl differentiates itself by enabling individuals to lend to secure and well-established companies. Unlike other peer-to-business lending sites, individuals do not invest directly in individuals or businesses seeking start-up or development capital. Instead, they lend to established suppliers and the money is linked to leasing agreements. Savers bid on investment opportunities and a loan offer is made, specifying the amount and required return. Risk is reduced because the company only accepts public sector and major listed public companies and it limits the amount of money a saver can lend on any deal to 5 per cent of the total value of a loan application from a supplier. Rates of return average from 6-7 per cent for low-risk deals, to 9-12 per cent for the smaller business market. Lenders are charged no fees.