Fed up with earning next to nothing on your savings? Or tired of lenders charging you an arm and a leg for borrowing money? Well Zopa, a web-based marketplace that brings together private lenders and borrowers, reckons it can come to your rescue by cutting out the middleman (i.e. banks) to leave everyone better off. Sounds a nifty idea, but does it work?
Let’s start by taking a quick look at what’s involved for each party.
Lenders
You can lend from £10 upwards and provided you lend £500 or more your money will be split between at least 50 borrowers to reduce the impact of any bad debts. You can choose how much interest to charge each of five groups of lenders, categorised by their credit rating, and whether to lend for three of five years. In practice you’ll need to set your rates at about the average if you’re to stand a chance of borrowers wanting your money.
Once your money is lent out you’ll receive monthly repayments unless the borrower defaults, in which case Zopa will chase the money, using a collection agency if necessary. However, bad debts are possible and Zopa also charges a 1% annual lenders fee, so you’ll need to factor these into the rates you request.
Interest is paid gross so you’ll need to declare it on your tax return, but bad debts cannot unfortunately be offset against interest received. If a borrower dies then the debt will be passed onto their estate, so you should get back outstanding monies if there’s enough money in the estate.
So lending via Zopa is a bit like using a fixed interest savings account, except your return could be affected by bad debts, which are not covered by the Financial Services Compensation Scheme (FSCS).
Borrowers
You can borrow between £1,000 and £15,000 over three or five years. Once registered Zopa will carry out ID and credit checks then give you a credit rating (ranging from A* to C, or Y if you’re aged 20-25), which influences the rate you’ll be offered (based on the rates demanded by lenders). Rates offered can change on a daily basis, but once you apply for a loan your rate will be locked in provided you’re accepted and pay a £124.50 transaction fee.
Unlike most banks, you can overpay or repay your loan early without penalty. But fail to make your monthly payments and you can expect to be hounded by a debt collections agency.
Does it work?
To find out I took the following statistics from the Zopa website for a three year £5,000 loan:
| Credit Rating | Average annual rate offered (based on last 5 loans) | Expected annual bad debt rate | Anticipated lender annual return net of bad debts and annual fee |
|---|
| A* |
7.37% |
0.5% |
5.87% |
| A |
8.14% |
1.0% |
6.14% |
| B |
9.45% |
2.9% |
5.55% |
| C |
11.95% |
5.2% |
5.75% |
| Y |
11.61% |
5.0% |
5.61% |
| All rates taken from the Zopa website on 8 July 2010. |
The impact of bad debts will obviously depend on when they occur - for example, a lender defaulting early on will be more painful than later on, when they've already repaid much of the loan.
These rates compare to a current ‘best buy’ three year fixed rate savings rate of 4.15% gross (ICICI Bank) and personal loan rate of 8.8% (Sainsbury’s Bank).
So, on the surface, Zopa does seem to offer a good deal for both lenders and borrowers. But, if bad debts are higher than expected (certainly a possibility in the current climate) then lenders could see their returns dwindle, or even lose money - be warned! And borrowers should always compare rates to conventional personal loans to see whether they’re competitive (as rates can vary widely depending on your credit rating).
Zopa is a good idea that seems to work in this low savings rate climate. But if interest rates rise and/or bad debts increase in future then its appeal could start to diminish with both lenders and borrowers getting better deals elsewhere. And lenders should ensure they fully understand the risk of bad debts.