Update in Spring 2020: As a result of the ongoing Covid-19 crisis, all peer-to-peer lenders are having liquidity problems – in other words investors are not able to immediately get their money out even from so-called ‘Instant Access’ or similarly branded accounts. Ratesetter is no different. Nobody has lost any money with Ratesetter yet as far as I’m aware, but only a small amount of money is being released every week through its secondary market. Cautious borrowers should note the extra risks; even adventurous (/rich!) types should only invest money they can afford to have locked up for years in case it takes a long time for things to return to normal. In a worst case Covid-19 scenario you could lose some of the money invested. Please do your own research, and make your own decisions carefully.
I won’t 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 hard to get a decent interest rate on cash for the past few years.
Even the Bank of England’s rate rises haven’t done much. High Street banks always drag their feet in passing on rate rises.
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 some risk.
In practice, no Ratesetter investor has yet lost a penny. Every lender has received the rate they expected.
Nevertheless, peer-to-peer does not have the same protections as traditional cash deposits, so you should think about it differently to cash in the bank. More on that below.
If you can accept the risk and have 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.
Not a few Monevator readers have taken advantage of this win-win RateSetter offer over the past couple of years!
RateSetter is one of the new breed of peer-to-peer lenders aiming 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 get up to 5.4% as a lender with RateSetter by putting your cash into its five-year market.
Since March 2018 you’ve also been able to open a RateSetter ISA, which means you get your income tax-free.
Meanwhile borrowers can get a loan charging less than 4%. 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).
RateSetter charges no lending fees, which is great news for savers like us. Borrowers do pay a fee.
Over £2.5 billion has now been lent through the RateSetter platform. This is no longer a tiddly operation.
And importantly, of the 66,942 investors who’ve lent money with RateSetter not one has yet lost a penny of their investment.
In 2010 RateSetter set-up a ‘Provision Fund’, which is 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 initial approach of rivals like Zopa. Back then you were encouraged to spread your loans widely and accept a few would go bad, reducing your return.
The RateSetter approach is different.
But as sensible people of the world, we should understand there’s no magic 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 have gone to lenders through a higher interest rate.
However what the Provision Fund does is share those losses between all lenders, reducing everyone’s return a tad.
This makes your returns predictable. Your outcome should be dependent on the interest you receive – rather than being distorted by the poor luck of being personally hit by an unusually high number of bad debts.
Note that the Provision Fund does not provide complete protection against a situation where all the loans made at RateSetter default. Far from it!
Rather the Provision Fund aims to cover the bad debts predicted by RateSetter’s models, with a margin of safety on top.
At the time of writing, Ratesetter says:
In the event that credit losses were to increase significantly, the following things would happen:
The Provision Fund would reduce in value as it reimburses investors for missed payments.
The Provision Fund is large enough to cover credit losses up to 116% of expected losses. If credit losses rose above this level, the Provision Fund would be depleted and investors would earn less interest than they expected, but their capital would be unaffected.
If credit losses rose even further and exceeded 231% of expected loses, investors would start to lose capital, which means that they would get back less money than they put in.
In this instance, it may take longer than expected for investors to receive their money back and access to funds may be restricted.
What would happen if losses did exceed the RateSetter projections?
First the Provision Fund would be used up, and ultimately exhausted.
After that interest payments could be redirected to repaying capital. You’d lose on interest payments, but it could cover lenders’ losses on capital unless the default rate got too high.
Finally, in a doomsday scenario with very high default rates, capital could be eroded. I’d expect other investments like equities and corporate bonds would also be taking a pummeling. But cash in the bank would not.
At the end of the day, I believe for most people the Provision Fund approach is preferable to the lottery of individual loans defaulting. 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.
This £1,000 minimum investment can be made up of new subscriptions and/or transfers from other ISA providers.1
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, which matches the period required to qualify for the bonus.
The one-year market is paying 4.7% as I type.
So after one year you’d have your 4.7% interest on your £1,000 and you’d also receive your bonus, which works out as a return of 14.7% on your £1,000.
I’ve ignored taxes here because everyone’s tax situation is different.
The good news on taxes is that:
- You can now open a RateSetter ISA and collect the bonus. You can fund this with a transfer from another ISA provider. In an ISA the income you earn is tax-free.
- Most people even outside of an ISA will pay no tax on cash interest, thanks to the new-ish Personal Savings Allowance that covers the first £1,000 of interest earned by 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, 4%, while paying you an effective rate of nearly 15%.
(The cost is even higher to RateSetter if it pays me a bonus, too.)
RateSetter must be hoping this is the start of a multi-year relationship with its new sign-ups, after they become comfortable with its platform.
Once you get over the initial hurdle, peer-to-peer is straightforward. I’ve used these platforms for ten years now.
RateSetter will 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.
Finally, I expect the cost of this offer is allocated internally to its 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.
I do think it’s a smart question to ask, though, 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 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 bail you out like they would for up to £85,000 with a High Street bank savings account.
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 (in my opinion) worst-case scenario, the Provision Fund would not be able to cover all the bad debts. This would mean some loss of interest.
- According to RateSetter, as of August 2018 the loss rate experienced to date is 2.29%.
- It currently projects this to rise to 3.33%. (Loans take a while to go bad.)
- If credit losses rose to 127% of expected losses, RateSetter‘s model indicates the Provision Fund would still cover interest.
- In what RateSetter terms a severe recession, you’d get no interest but it believes you’d get your initial money back.
- If we saw 400% expected losses, investors might lose 5.6% of their capital.
This illustration is summarized in the following chart:
As for the worst worst-case scenario, like with any business it is possible to imagine catastrophic situations where you’d lose much more.
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 a hint of what might have gone wrong came in 2017, when the company intervened to restructure several businesses and cover repayments from one via its own funds. This prevented its bad loans from being defaulted to the Provision Fund. This decision to intervene reportedly2 delayed authorization from the FCA. It has subsequently been granted.
RateSetter says: “This intervention was an exception and will not happen again.”
As I understand it, RateSetter has since withdrawn from the wholesale funding operations that produced this situation. (Wholesale funding is when a company lends money to third parties, who then lend those funds on themselves.)
You invests your own money and takes your choice.
Personally, I am happy with the risk/reward here. Not everyone feels the same. My 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 have always taken a pick-and-mix approach to spread the risk with these sorts of alternative opportunities.
For instance, I have used 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 low single-digit percentage of my net worth with any particular platform. 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 peer-to-peer articles barely mention it, 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 do hope some of you found this article interesting and enjoy those bonus-boosted returns.
- Note: Terms and conditions apply with transfers, so check the small print. The money must be transferred over within a certain time period, which may be down to the ISA provider you’re transferring from. Just setting up a new RateSetter ISA with a fresh £1,000 should be straightforward. [↩]
- See this article at Reuters: https://uk.reuters.com/article/uk-interview-ratesetter/ratesetter-recovering-after-asteroid-strike-bad-loan-discovery-idUKKCN1BN1PF [↩]