* This offer now requires you to invest a minimum of £5,000 to get the £100 bonus, which clearly changes the maths. I’ll update this article when I get the chance.
I am not going to cause any readers to fall to their knees screaming “No! How can it be? Why didn’t somebody tell me!” if I say it’s been very hard to get a decent interest rate on cash for the past few years.
But in this article I’ll explain how you can effectively get a 14% return on a chunk of your cash by taking advantage of a bonus offer from RateSetter, the peer-to-peer lender.
True, this very attractive potential return does not come without risk.
Peer-to-peer does not have the same protections as normal cash deposits, and you should think about it differently to cash in the bank. More on that below.
If, however, you have the risk appetite for it and the spare cash to hand, I believe this is a pretty safe – though not guaranteed – way to make a good return.
It also exemplifies how being nimble with your money can enable you to achieve higher returns – even in today’s low rate world.
RateSetter is one of the new breed of peer-to-peer lenders that aims to cut out the banks by acting as a matchmaker between ordinary savers and borrowers like you and me.
Rates change all the time, but as I write you can for example get up to 6.1% as a lender with RateSetter by putting your cash into its five-year term market.
Meanwhile borrowers can get a loan charging 7.9%. RateSetter claims that rate is competitive with the mainstream banks, and says banks are its competition (rather than it simply getting all the bank rejects).
In April 2014 RateSetter scrapped its lending fees, which was great news for savers like us. Borrowers do pay a fee, though.
Importantly, of the 34,778 individuals who’ve lent money with RateSetter not one has lost a penny of their savings.
That’s because in 2010 RateSetter set-up a ‘Provision Fund’, which is now funded by charging all borrowers a risk-adjusted fee.
Money from the Provision Fund is used to repay lenders whose borrowers miss a payment, for as long as there’s money in the fund to do so.
It’s a different model to the earlier peer-to-peer approach of platforms like Zopa, where instead you were encouraged to spread your loans widely and accept a few would go bad, reducing your overall return.
Zopa has since introduced its own Safeguard protection that aims to cover lenders for losses, similar to and following in the footsteps of RateSetter.
As sensible people of the world, we should understand there’s no magic going on here. Some loans will still go bad. And those bad loans will still reduce the returns enjoyed by lenders in aggregate – because the Provision Fund fee levied against borrowers as part of the cost of their loan could otherwise go to lenders in the form of a higher interest rate.
However what the Provision Fund (or Zopa’s Safeguard) does is share those losses between all lenders, reducing everyone’s return a tad.
This makes returns more predictable, as your outcome should be dependent on the interest you receive – rather than being distorted by the bad luck of being personally hit by an unusually high number of bad debts.
Note though that the Provision Fund (obviously) does not provide complete protection against all the loans made at RateSetter defaulting. Far from it.
Rather it aims to cover the bad debts predicted by RateSetter’s modelling, and in addition a margin of safety.
If the Provision Fund ever ran out of money then interest payments could be redirected to repay capital unless the default rate pushed past 11% or so, according to RateSetter’s projections. Bad, but still quite a safety cushion given the relatively high rates on offer.
I think for most people, the Provision Fund approach is better than the lottery of individual loans defaulting and it is a comfort, but don’t mistake it for a panacea or a guarantee.
You could conceivably lose money if defaults are much worse than expected. More on that below.
How to bag that 14% return from RateSetter
At last, the good bit!
RateSetter is currently offering a £100 bonus to new customers who invest at least £1,000 in any of its markets and keep it there for a year.
The £100 bonus is paid once that year is up. It will be deposited into your RateSetter account, after which you can choose to do with it (and the rest of your money) as you please.
For full disclosure, RateSetter will also pay me a £50 bonus if anyone does sign-up via my links, which would obviously be very welcome! My bonus doesn’t affect your returns. It’s paid by RateSetter.
As for your £1,000 investment, you can put it into any RateSetter market, which range from a rolling one-month option to a five-year lock-up. But you must keep it within RateSetter for a year to get your £100 bonus.
To keep things simple, let’s assume you invest your £1,000 in the one-year market, given it matches the period required to qualify for the bonus.
That one-year market is paying 4% as I write.
So after one year you’d have your 4% interest on your £1,000 and you’d also receive your bonus, which works out as a return of 14% on your £1,000.
I’ve ignored tax here on the interest because everyone’s tax situation is different.
Note though that from April 6th, most people will be paying no tax on cash interest thanks to the new Personal Savings Allowance that covers the first £1,000 of interest for basic rate taxpayers, and £500 for higher-rate payers.
Is this bonus too good to be true?
A great question.
Clearly it’s not sustainable for RateSetter to lend your money out at, say, 8%, while paying you an effective rate of 14%.
(The cost is even higher to RateSetter if it pays me a bounty, too – approaching 20%.)
However RateSetter will surely be hoping this is the start of a multi-year relationship with its new sign-ups once they become comfortable with its platform.
It will also hope many customers deposit more than £1,000 and ultimately prove profitable in the long-term.
Like all peer-to-peer lenders, RateSetter will be aiming to scale as quickly as possible. Greater size will improve its margins and enable it to continue to meet demand in both the savings and loans market. Scale is a critical factor in virtually all money-handling businesses.
I expect the cost of this offer is allocated internally to the marketing department. If 5,000 people sign-up for the bonus that’s clearly a lot of money – but it wouldn’t buy very much TV airtime. At least this way RateSetter can precisely calculate the return on its investment.
But I do think it’s a smart question, and it neatly brings us back to risk.
A final word on the risks
I have already stated that peer-to-peer lending is not a straight swap for a cash savings account. The risks are much higher.
Firstly and crucially, there’s no Financial Services Compensation Scheme coverage for peer-to-peer lenders. If you lose money, the authorities will not be bailing you out like they would for up to £75,000 should your conventional High Street bank get into difficulties.
That’s important because even though no savers have yet lost a penny with RateSetter, that’s not a guarantee they will not do so in the future.
The economic situation could change markedly, say, or RateSetter could get its sums wrong on bad debt.
In the most likely worst-case scenario (in my opinion) the Provision Fund would not be able to cover all the bad debts. This could mean some loss of capital.
- According to RateSetter, as of January 2016 the default rate was 1.8%.
- It says the Provision Fund would not run out unless the default rate breached 3.2%, beyond which point interest payments could be used to cover capital losses.
- At a 11.46% default rate, RateSetter still projects lenders getting their capital returned intact, albeit with no interest.
- Even if defaults hit 20%, RateSetter says lenders would still only lose 8.5% of capital – bad, but given that it says the default rate in the midst of the credit crisis in March 2009 only hit 5.5%, a seemingly remote prospect.
As for the worst worst-case scenario, you can imagine catastrophic situations where you would lose everything.
But to my mind these would probably require fraud or massive incompetence within the company, and/or a far deeper recession than anything we saw in 2008 and 2009. (Probably both at once – as Warren Buffett says you only see who has been swimming naked when the tide goes out.)
Obviously I don’t think that’s at all likely, otherwise I wouldn’t have put any money into RateSetter.
But you invests your own money and takes your choice.
Personally, I am happy with the risk/reward here. Not everyone feels the same. My own co-blogger, for instance, doesn’t use any peer-to-peer platforms.
As a halfway house to reduce risk one could perhaps only invest in RateSetter’s monthly market, in the hope this would give you more chance of getting money out relatively quickly if say the economy was coming off the rails. The price is a lower interest rate, of course.
I think it’s worth stressing again that nobody has lost money so far with RateSetter. And even if the economy turns very far south, you probably won’t lose more than a small percentage unless something very bad or criminal happens.
That would be a much worse situation than with cash, but not a catastrophe.
However we all know by now that bad things can happen, and every investment can fail you. Do not invest money you cannot afford to lose.
RateSetter and your portfolio
Personally I use take a pick-and-mix approach to spread the risk with these sorts of alternative opportunities.
For instance, I use both RateSetter and Zopa, I’ve invested a little in mini-bonds and retail bonds, I have money with NS&I, and I have taken advantage of high interest rates and cashback offers with accounts like Santander 1-2-3 to boost my returns.
When putting money into the riskier alternative options, I only invest a very low single-digit percentage of my net worth with any particular one. Like this I aim to mitigate the risks of being hit by some sort of systemic or company failure.
I’m not going to labour the point on risk further – most articles barely mention it when discussing peer-to-peer, and I’ve devoted half this piece to it. Consider yourself warned, and read the company’s extensive material if you want to know more.
I think peer-to-peer and other cash alternatives are interesting additions to our arsenal as private investors, but they’re not slam dunk safe bets. I size my exposure accordingly.
Get your £100 while it lasts
So there you have it – a hopefully even-handed assessment of the risk and reward potential of this £100 bonus offer from RateSetter.
From here you’ll have to make your own mind up.
I will be covering peer-to-peer again the next few weeks thanks to the imminent introduction of Innovative Finance ISAs, which several readers have asked about.
Watch this space! In the meantime, I do hope some of you found this article interesting and go on to enjoy those bonus-boosted returns.