The three big peer-to-peer lenders have all reported falling returns for investors of late. Is this a sign of things to come?

Curious, I thought: Zopa has stopped showing average returns for lenders over 12 months on its website and has reduced them to six months. After many years of dealing with financial companies, my instincts were screaming about this suspicious change.

But it turns out that Zopa – one of the few shining lights in a financial industry full of greed, selfishness, deception and bankers – was actually doing the decent thing.

The average return for Zopa investors after charges and bad debts over 12 months to the end of March 2013 has fallen to 5.4% from 5.7% a year earlier. However, in the past six months, as Zopa shows, the return has averaged just 5.1%.

Zopa considers the six-month figure to be more representative and has chosen to be fair to potential investors by showing the lower figure, which indicates Zopa is not trying to make investors think they can expect more than they should.

Bad debts have risen at Zopa, which could be the cause. However, at less than 1%, they're still incredibly low by any measure, and especially compared to high-street banks. Since Zopa has not loosened its credit checks, it's likely that continuing personal financial problems are the main cause.

A similar story at RateSetter

Zopa competitor RateSetter has also revealed that rates are down across its four types of loans. Taking its five-year loan as an example, investors' current rate of return is 5.4%, compared to an average 7.1% in 2012.

Unlike Zopa, RateSetter lenders all earn the same amount, since loans are pooled differently and bad debt is accounted for in a separate pot. This means investors' returns are more certain and has a slight tax advantage over Zopa, although it diminishes investors' ability to choose their own rates and pick superior loans for themselves.

With the extremely low bad debt of less than 0.4% easily contained by RateSetter's substantial Provision Fund, this has not impacted investors' results.

Toby Pellew of RateSetter believes rates have instead fallen because of increased competition. With far more investors signing up to offer loans, it has driven down the interest rates offered to borrowers.

Average lender returns since peer to peer began

Zopa started in March 2005. According to my records and new data from Zopa, average returns after charges and bad debt have been like this:

12 months to... Average annual return after bad debt and charges Average annual return after 20% income tax Real after-tax return after RPI inflation Bad debt March 2006 6.8%* 5.4% 3.0% 0.1% March 2007 6.8%* 5.3% 0.5% 0.3% March 2008 6.8%* 5.1% 1.3% 1.3% March 2009 6.8%* 5.1% 5.5% 1.6% March 2010 7.2% 5.3% 0.9% 2.1% March 2011 6.9% 5.3% 0.0 0.9% March 2012 5.7% 4.5% 0.9% 0.2% March 2013 5.4% 4.3% 1.0% 0.2% Average since March 2005 6.5% 5.1% 1.7% 0.8%

*I don't have the annual return figure for the individual years up to March 2009, but this is the average across all four of them.



The after-tax returns shown might be a little lower than you expect, partly due to rounding, but mostly because you can't offset Zopa bad-debt losses against interest earned.

This table shows an average across all Zopa loans, meaning all credit risks on loans lasting between one and five years.

RateSetter – all-time average rates of return

Let's take a look at RateSetter investors' average returns since the website started offering its four different types of loans:

Type of loan Average annual return after charges (which includes any payments to the bad-debts provisional fund) Monthly Access 3.6% One Year Bond 4% Three Year Income 6.2% Five Year Income 6.3%

These rates are calculated from 2011 onwards for the monthly access and three-year income loans, and since 2012 for the rest. These figures are before declaring your taxes on your self assessment tax return/

RateSetter – current rates of return (April 2013)

That was the average since RateSetter began, but let's also take a look at what investors currently earn before tax with RateSetter:

Type of loan Average annual return after charges (which includes any payments to the bad-debts provisional fund) Comparable top online savings account protected by FSCS Monthly Access 2.4% 2% One Year Bond 3.2% 2.25% Three Year Income 4.2% 2.46% Five Year Income 5.4% 2.9%

The comparison to savings accounts shows you the return investors expect for the extra risks in investing through RateSetter. Although rates have fallen in the past year, investors in five-year loans are still making a fair bit more than with traditional savings accounts. Investors in monthly loans are willing to take the additional risks for surprisingly little gain, however.

Peer-to-peer lenders are not yet covered by the Financial Services Compensation Scheme, although Zopa, RateSetter and Funding Circle have successfully lobbied for this, so it's coming soon. Read Peer-to-peer lending set to be regulated.

Funding Circle

The final member of the big three peer-to-peer lenders is Funding Circle, which provides loans for businesses rather than individuals.

David de Koning from Funding Circle tells me it is currently improving the information it has on historical returns after charges and bad debt, and that I should be able to get it in a month or so. In the meantime, he could tell me that the current return is 6.2%, even after bad debts of 1.6%. That's also after Funding Circle charges, but before taxes.

Looking at a graph he sent me, it seems that Funding Circle investors have seen a small dip in returns over the past six months or so, which is rather like the other two services.

The past doesn't reflect the future

Zopa might have decided it was fair to focus attention on the more recent past, but while this is commendable, ultimately it will probably not represent the future.

Whether Zopa chose the past six or 12 months makes no difference. Using the past for forecasts, in both investing and in economics, has constantly been shown to be baloney, even though statistics generate lots of exciting headlines and they are, incredibly, still widely used by both amateurs and professionals alike.

Investors just don't want to accept that it's a lot more complicated than that.

The future of peer to peer

As we have seen in the decreasing interest-rate figures, there are signs that investors are already accepting lower returns for the risks they're taking after just a few short years.

I'm certain that these websites, and more to follow, will be around for a long time to come, offering fair returns to many investors – but only if investors keep a close eye on the risks, and bail out when the potential earnings don't match the risks involved.

Don't be complacent just because peer to peer has worked out so well, so far. Like every other investment bar none, there will be good times – and there will be bad times for those who get carried away by greed and euphoria.

What do you think? Are you investing through a peer-to-peer lender? What has your experience been like? Let us know in the comment box below.

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