How Peer-To-Peer Lending And Crowdfunding Work

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Written By Mostafa Moradi

How Peer To Peer Lending And Crowdfunding WorkInvesting is a balance between risk and return and deciding how to get the best return for the least risk is a constant battle for any investors.

With thousands of investment options vying for cash, how do you pick the best deal?

Two of the latest popular alternative investments are peer-to-peer lending and crowdfunding.

There’s a sliver of difference between the two and peer-to-peer lending is a relatively new kid on the block without much of a history to base decisions on.

Peer-to-peer lending is where one or more private investor’s bank roll an individual or business with a loan over a short term typically for a fixed rate return

Effectively, peer-to-peer lenders cut out the financial middlemen who add costs to a loan.

Peer-to-peer lending explained

Because the process of marrying a borrower with lenders is carried out online, the process is cheaper and quicker.

The platform still credit checks and underwrites the loan in the same way as a bank, and the lender has the right to say no to a deal.

If the loan proceeds, typical terms are 12 to 60 months for an average fixed rate return of 6%.

Interest can be paid monthly or yearly and is taxed at the lenders marginal rate.

Although peer-to-peer lending is regulated by the Financial Conduct Authority (FCA), peer-to-peer lending is outside the Financial Services Compensation Scheme (FSCS).

If a debt goes bad, the lender has recourse to a recover the money from a reserve fund maintained by the peer-to-peer lending platform or through the courts.

Crowdfunding options

Crowdfunding is where two or more investors pool small amounts of cash to fund a project. This can be debt or equity funding and is generally tied up in a business for around five years before the investor sees a return.

Like peer-to-peer lending, crowdfunding is regulated by the Financial Conduct Authority (FCA) but outside the Financial Services Compensation Scheme (FSCS).

Business borrowing is the norm for crowdfunding, as entrepreneurs are keener to share the risk and give away some equity to investors rather than take on the drain on cash of debt equity, especially for a start-up.

However, serious investors are more likely to look for a Seed Enterprise Investment Scheme (SEIS) start-up company because of the generous tax breaks that are unavailable through crowdfunding.

Perhaps the best way to consider peer-to-peer lending and crowdfunding is the former is more like a return on savings, while crowdfunding is more of a long term gamble.