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Are rising Zopa interest rates an opportunity or a time-bomb?

Zopa I’ve just been checking out my Zopa savings account, where I’ve noticed interest rates are going up. I only ever lend to A and A* borrowers (people with great or better than great credit records) and the rate Zopa is quoting me as competitive is much higher than usual.

In fact, in the A*, 24-month market, I seem to be in the zone with an interest rate of 10.5%, which Zopa estimates will give me 9.5% after bad debt.

That 9.5% is almost 50% more interest than on the best savings accounts available from banks at the moment.

I’m gob-smacked.

  • Previously Zopa’s edge on normal savings accounts has been more 1-2% above the High Street banks.
  • The Bank of England is cutting interest rates, so this is a chance to ‘lock in’ a higher rate.
  • That 9.5% is close to my expected returns from the supposedly much riskier stock market.

So should peer-to-peer Zopa lenders be filling their boots?

A quick Zopa primer

I’ve been meaning for ages to write up my experiences with Zopa, but a quick primer will have to suffice for now.

Zopa is a peer-to-peer lending site that’s been going in the UK for about three years, and recently launched in the US, Japan and Italy. It’s completely legitimate in terms of its business (although some criticize its business model!) It’s been covered by both the BBC and the FT.

Set up by experienced bankers who created Egg in the UK, the best analogy is it’s sort of like an eBay for money. As a lender you offer loans to members, while other members borrow money. You get access to the same credit checking the big banks use (or don’t use), and there’s (theoretically) all manner of checks and balances built-in to enable you to see what kind of rate you’re getting.

The big difference between putting money into Zopa and a normal savings account is that you can lose your money with Zopa.

There are safeguards against this – you might choose to only lend, for example, £10 to each borrower, and bad debt is taken into account in the expected returns – but it’s still a crucial difference. On the other hand, I’ve not yet had a bad debt, and nor has a good friend who has been a lender with Zopa for over two years.

I still plan to write a long post about Zopa soon, as it’s really fascinating. If you want to know more before reading on, check out that BBC story on Zopa.

So, should I lend money like crazy at 9.5%?

Clearly, the credit crunch is having an effect on Zopa’s peer-to-peer lending market, either by:

  • Increasing the number of Zopa borrowers, and so decreasing the pressure for lenders to compete via reducing rates.
  • Reducing the number of lenders, and so reducing the range of offers for borrowers to choose from.
  • Making lenders nervous, so we’re all raising our rates.

Plus I see a fourth, really unpleasant possibility:

  • More lower-quality (or even dishonest) borrowers are coming to Zopa.

Which is it? I wish I knew. If I could be certain those A* borrowers wouldn’t default in droves in the next 24 months, I’d take a 9.5% return like a shot. Certainly, if a big High Street bank was offering that interest rate, I’d sell down some of my shares to take that as a guaranteed return.

But Zopa lending is not guaranteed, and that’s a very big but indeed.

I’d say the likeliest cause of the rate spike is a combination of all of the factors I mentioned above. Rising rates in a system like Zopa make sense even if rates are falling elsewhere, because lenders like me always have the opportunity to just stick our money in a bank account instead if we’re unsettled, and will demand more return for taking the risk. And if Wall Street and the City is nervous about lending money because of rising bad debts, we should be, too.

On the other hand, my A* borrowers are (theoretically) the creme de la creme of customers. You can lend to sub-prime borrowers at higher rates on Zopa, but I don’t. So the risk of a mass default for me should be small.

The biggest issue for me is Zopa has not yet been tested in anger. We haven’t yet seen how individual borrowers will behave in a peer-to-peer system if money really becomes tight. With some economists predicting a 1980s-style recession in every way except the shoulder pads, that’s a very real risk.

On balance, I’m going to increase my lending a little, but not go crazy. I originally explored Zopa as an experiment, and it’d be terrible to discover that I’m the unfortunate guinea pig should the experiment turn sour.

Update: I’ve written a significant update of my positive experience with Zopa as of January 2009. You might also read this article from the FT.

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{ 9 comments… add one }
  • 1 DavidD March 28, 2008, 11:12 pm

    I thought I would give Zopa a try, I have been meaning to for some time. I have used your link.

    Great site by the way.

    Keep up the great posts.

    David

  • 2 The Investor March 29, 2008, 11:44 am

    Thanks for your kind words David, and perhaps tell us how you get on with Zopa?

    Personally I’d certainly not move vast sums into Zopa at once… maybe several £500 batches until I reached my comfortable exposure. That way I’d benefit from having exposure to different tranches of borrowing conditions / borrowers.

    In the blog article track backed above, the writer mentions Zopa’s default rates aren’t being seen as rising at all, which is good news if it turns out right.

    Pays your money and takes your choice though, and as ever on the site this shouldn’t be taken as advice.

    Good luck!

  • 3 Anthony Mckenzie November 13, 2008, 2:38 pm

    Hi,
    Just followed your link to “ZOPA” considering loaning money,
    You suggest that we could both get £30.00,
    they actually will send £50.00 to the person who recommends someone and suggests that they might split it with them.
    would you agree to this.
    Regards
    Anthony Mckenzie

  • 4 The Investor November 14, 2008, 3:00 am

    Hi Anthony,

    I see, they must have changed the rules — I’ve never actually got any money out of this link as it happens. 🙁

    To be honest I’m afraid I can’t go splitting money with people on the Internet I don’t know. It seems rather dangerous – no offence, nothing personal, obviously I don’t know you from Adam.

    If you don’t think it’s fair that I should get some money, that’s fair enough… to stop it happen you’ll need to go to security or similar on your browser, and ‘delete cookies’. Then go back to Zopa (without going via my link). That should stop me getting a payment, although it won’t mean you get any extra money.

    Best of luck if you do take the Zopa route. I’m happy so far, but I do wonder how it’ll fair in recession, if people start defaulting.

  • 5 Wappers December 8, 2008, 1:50 pm

    I suspect the increase in rates is due to Credit card companies rates skyrocketing, e.g. MBNA Virgin now charge 35% to a lot of people.

  • 6 Craig P January 16, 2009, 5:44 pm

    I think the strange thing isn’t that rates are so high in zopa its that they are so low for banks, they are being forced low by government preasure.

    It seems to me that zopas rates are far more accurate as a way of seeing the increased risk of default on debt, so I would say it isn’t a bubble.

  • 7 R. Lister January 26, 2009, 2:45 pm

    If I lend, say £5000, to ZOPA and then, unexpectedly, need this capital sum back, can ZOPA return it all to me, less a small charge presumably, and, if so, how long will it take to get it back?

  • 8 The Investor January 26, 2009, 3:46 pm

    @R. Lister – not as I understand it, no. Your money is locked away for the term of the loans you agree.

    NOTE: You don’t lend the money to Zopa, you lend it to individuals via individual contracts. Zopa is the mediator (and has some other obligations, as per details on its website). Ideally you lend it to many different people (I only lend £10 max per loan) with Zopa packaging up the microloans to make big loans for applicants. This reduces your risk.

    In short, if you want or need ready access to your money, Zopa is not for you.

    I am going to do a step-by-step guide to Zopa soon, so watch this space! 🙂

  • 9 James Mucci April 13, 2010, 4:44 am

    Opportunity for investors into the peer to peer lending space seem to be growing, and yes I agree that it’s probably because of the tighted credit everywhere else. One thing to consider, many of the regulation changes that are being imposed are also causing higher opperating costs for lenders and bank, which result in higher rates to consumers.

    Peer to peer lending can be a great alternative, or even a source for borrowers and investors alike.

    .-= James Mucci on: Wondering Why it’s So Hard to Get a HELOC? =-.

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