saving

A quick update to my post of last week discussing Zopa rates rising because of the credit crisis. Rates have now come down - my main lending offer to A* customers is now out of the ‘Zone of Possible Agreement’ (ZOPA), which in English means people can get such better rates from other Zopa lenders that they’re unlikely to call on my money.

I would have to drop my rates down to around 8.25% to re-enter the ZOPA, which I’ve decided not to do for now. In these riskier times, I want some extra security from this sort of peer-to-peer lending, so I’m going to leave my money offered at that current rate and hope for another cut in supply in the weeks ahead.

Zopa sensibly pays you an okay interest rate on money sitting in your account, so you don’t have to rush. It’s a lot less than what I could get from actual Zopa borrowers, but this isn’t the time for hasty moves I feel.

So there you go. Gold has fallen, the stock market is up, and Zopa is possibly signaling the credit crisis is abating. It’s certainly proving an interesting new barometer to keep an eye on.

Apparently there’s still £30 up for grabs through Zopa’s affiliate scheme for new members, but do check if you decide to sign up, as the small print would seem to contradict this. If anyone from Zopa is reading, you might like to update those details?

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.

If you want to know more, visit the Zopa website, or read this FT article. (Zopa links tell the site I sent you, which at the time of writing can give us both £30 if you do choose to lend or borrow. Which is nice.).

We can’t wish away the credit crisis. However sensible you or I have been with our investments, borrowing and spending, we can’t wind back the clock and stop bankers throwing money at poor people who’ll never be able to pay it back, and who are often now paying a far higher price – repossession, dislocation, or even bankruptcy.

The bankers did it, everyone got cold feet, and now we all have to live with the consequences.

However rather than putting on The Smiths, pouring myself a large gin and tonic, and turning to Sylvia Plath, I thought it’d be more useful to assemble a checklist to help you avoid suffering too much fallout from this banker bungling. Who knows, you might even come out of the credit crunch richer! Personally, I’ll be happy with older and wiser – and not much poorer…

Today I look at personal finances. Tomorrow I’ll offer quick checks on investment, your income and more, so please be sure to subscribe to my feed.

1. Get out of debt

Because of the credit crunch, money is becoming more expensive.

I’ve written before about why you must get out of debt. But with the credit crunch being described as a great ‘deleveraging’ (in human speak, banks are reluctant to make new loans, and may even be calling them in), borrowing money instead of saving to buy things is getting even more expensive.

What it means for us

• If you’re already in debt, I’m not saying your bank is going to call you up tomorrow and demand all it’s money back. Rather, the climate is turning against borrowers for the first time in years.
• Banks are increasing loan rates where they can.
• They are less willing to enable customers to shuffle debt using cheap balance transfers.
• They will look much more carefully at impaired credit records, which will be a factor if you’ve been missing payments.

Action plan

Get out of debt, ASAP. Normally blogs work best when writers tell you personal stories, but I hate debt with a passion and have avoided it ever since I left college. If you’re struggling with debt, one of several good blogs on the subject is Blogging Away Debt. (But please comeback soon!)

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Cash is the safest place for your money in the short-term.

Sounds obvious, but cash is money. Shares, property, bonds, gold and pension funds are all assets whose value constantly fluctuates according to the whims of their markets. You can only be certain what such assets are worth when you come to sell them.

In sharp contrast, while the real value of a £20 note will go down due to inflation over the long-term, short-term it’s the safest store of value there is. You know it’s worth exactly… £20.

The price for this safety is you can expect lower returns from cash compared to investing in shares, over periods of five years or more.

Note that I’m talking here about keeping the interest you receive in the savings account, to benefit from compound interest over time.

If instead you spend the interest you receive, the real value of your savings will go down with inflation. Right now that would mean your cash would lose 3-4% of its spending power every year.

Despite the low returns, everyone needs some cash stashed away for a rainy day – or more specifically for when the roof leaks and you need to get it repaired.

You’ll also want cash savings for near-term known expenditure, such as school fees or a house deposit. You don’t want to lose your dream home because the stock market happens to be having a bad month when you come to buy, for example.

You might also keep some proportion of your long-term investment money in cash, depending on your views on the stock market, and increase the proportion in cash savings if you’re feeling very gloomy.

Just remember, over time you risk losing out to inflation, so you really want your long-term money in assets like shares or property.

Cash savings are the simplest of investments, but there’s still plenty to cover. Let’s get going.

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Last night Alastair Darling, the UK Chancellor, guaranteed 100% of savings in Northern Rock – and indeed the Financial Services Authority has since gone further, stating this guarantee extends to other troubled financial institutions that might emerge in coming days.

Given the scenes we’ve witnessed since Thursday’s news that Northern Rock required a lifeline from the Bank of England, many will think it’s a good move. And sure, the decision will probably quieten the recent financial upheavals. It will certainly get the government off the hook for now (and to be clear, I don’t believe the government was responsible for the problems in the first place).

But it is without precedent in the UK, and has potentially serious consequences that sound academic but which in extreme cases have previously led to unpleasant upheavals of the blood and barricades variety. What’s worse, the guarantee has for now come without any balancing regulation to ensure the banks do not abuse the facility for their own ends.

At the very least then, a move designed to bring short term confidence to the UK banking system will prove embarrassing for years to come, with consequences for all of us in Britain who save, borrow and spend. Everyone, in other words.

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