If you’ve ever bridled at the perceived injustice of paying 10% plus on borrowed money from a bank but getting only 5% on savings deposits, then listen up. Of course, the 5% differential is swallowed up in an array of bank overhead costs; administration, branch fees, salaries and big expensive television adverts telling you how "wonderful" they are. And then there’s the bank profit margin on top. All told, using a bank for your conventional lending and borrowing is a pretty high cost and inefficient way of employing your money in the internet age.
That’s why the banks are starting to get rattled by a new "social" model of lending that cuts out the middleman and delivers all the benefits of a low-cost infrastructure to both its borrowers and its lenders.
The borrowers pay lower fees; the lenders get higher rates. So who needs those banks anyway? Zopa (Zone of Possible Agreement) is an internetbased system that introduces lenders directly to borrowers, using a credit checking system that protects lenders from risking their money on complete chancers. It’s only been going since 2005, but already it has 150,000 members, with borrowers paying an average of 6.75% gross. Its 50,000 lenders average 6.25% return after a 0.5% annual fee. Not a fortune but ahead of most savings rates and likely to increase in a rising interest rate cycle like that currently prevailing. And Zopa hardly ever spends anything on advertising. Indeed, why would it need to when the basic deal it offers is so competitive?
Zopa, then, is fast becoming the banking equivalent of eBay. It isn’t a bank, any more than eBay is a shop. Instead, it lines up lenders and borrowers and then sets up a structure whereby they can find out whether there are enough people interested to make a deal work. By no particular coincidence, it’s backed by the people who started eBay in America.
Zopa was originally dreamed up by Dave Nicholson, a strategy manager at Egg, who split off, together with a group of his senior colleagues, to set up the new venture.
The team has grown somewhat since then, with operations in both Britain and the United States. The UK arm is led by CEO James Alexander, a former Strategy Director at Egg, and Tim Parlett, who managed Barclays’ settlement systems. Chief Financial Officer Giles Andrews comes from Tesco Personal Finance, and Global CEO Doug Dolton has previously run two internet lending agencies in the States.
How Zopa works
Zopa’s online credit vetting system invites potential borrowers to subject themselves to online credit scrutiny by ratings agency Equifax, using a sliding scale that runs from A* (excellent) down to D (poor) . If the borrowers don’t score at least a C, then Zopa won’t deal with them at all. The system, at www.zopa.com, is online and operational 24 hours a day.
Zopa approved lenders get invited to set out the terms on which they’d like to lend their money. For instance, a lender might say: "I want to lend £10,000 to B-rated borrowers for five years, but I’ll want an 8.5% return because they aren’t A-rated." And Zopa will put together a package whereby the lender’s £10,000 gets spread among several hundred B-rated borrowers — each of whom individually gets only a tiny fraction of the money, so as to spread the risk of default as thinly as possible. For C rated borrowers, the returns to a lender can be as high as 14%!
It might take a short while for the lender’s loan package to be assembled, but he or she gets 4.5% interest right from the word go. Then once the deal with the various borrowers is finally done, the borrowers make their monthly repayments to Zopa in the usual way by direct debit, and Zopa passes the accumulated cash back to the lender. The cost of the service is covered by a 0.5% one-off fee to the borrower, plus a servicing fee of 0.5% a year to the lender. Which is a whole lot less than a bank creaming off 5%. Any missed loan repayments are chased up by Zopa in exactly the same way your bank would do.
Defaults? Currently they’re running at only 0.05%, which is less than a tenth of the rate that the banks normally claim. And obviously, since you’re shouldering the risk of default when you lend through Zopa, that means that you’ll take the full impact of any shortfalls from your borrowers. (Bear in mind here that your risk has been spread among hundreds of different borrowers, so the chances of any one of them hitting you for more than £10-£20 are fairly slim.) But a quick word of warning here — Zopa’s 0.05% default rate is likely to rise as time goes on, because defaulters tend not to show up until a loan has been running for a fair while, and Zopa simply hasn’t been going for long enough to have reached normal "operating temperature" on defaults, as the banks have done. It’s too early to be comparing like with like.
Already some of the leading banks are starting to whinge about the amount of business that seems to be going the way of Zopa and its American counterpart, Prosper. Considering the loss of business, who could blame them?
Lend up to £25,000, borrow up to £15,000
But many of the lenders cite a more personal reason for preferring Zopa to the usual bank deposit route.
With Zopa, they say, they feel they’re helping people more directly than a bank would do, and the interpersonal element makes a real difference to how they feel about it. Borrowers, for their part, feel less ripped-off and less generally hostile to their lenders, because of that same interpersonal element. Which is rather odd when you consider that they’ll never meet their benefactors either.
If you want to lend, think about the interest rate cycle... As a borrower, can you pay off your loan at any time without incurring any penalties? Yes, apart from your initial 0.5% arrangement fee which will still need to be covered.
As a lender, can you vary the terms of your loan if bank interest rates change? No, they’re fixed for the life of the loan. So this year, when bank rates are probably at a cyclical high, could prove a good time to be considering lending money.
What are the limits for borrowing and lending through Zopa? For borrowers, loans can be between £1,000 and £15,000. Lenders, on the other hand, can invest anything from £10 to £25,000, or even more if they’re prepared to go to the hassle of getting a Consumer Credit Licence from the Office of Fair Trading.
Do you need to pay income tax on the interest from your Zopa lending? As you’d expect, yes.
Are you covered by the Financial Services Compensation Scheme in case it all goes wrong and Zopa goes bust? No, it’s not a member of the scheme, though it does have its own Consumer Credit Licence from the Office of Fair Trading. And Zopa says that it will indemnify its lenders against actual fraud.
How to get started
As a borrower, your first step is to complete the online credit application. You’ll need to be earning at least £25,000 a year, be on the electoral register and have a good credit record. Once you’re in the system, with an A*, A, B or C rating from Equifax, you’ll be shown a range of loan offers from various lenders, and it’ll be up to you to choose one of them. If you don’t find one you like, come back and try another day. Then, when your loan is finally ready to roll, you’ll be asked for a 0.5% arrangement fee, which will be tacked on to your loan.
As a lender, you set out your terms using the online form and wait to see whether Zopa can match your demands with a suitable parcel of borrowers. (Remember, there’ll be several hundred of them, so your risks will be very well diversified.) Once the loan is ready to roll, you move the money from your bank, or from an online Paypal account, to a holding account at Zopa. As mentioned, you’ll get 4.5% interest from the moment you transfer the money and for all the time it is not being lent.
Both sides will be locked into a legally binding contract with each other — which, in both cases, means that there’ll probably be a hundred or more tiny bilateral contracts. You won’t be aware of that panoply of complication, obviously, and nor will you need to deal with it personally. But it’s good to know that your risks are being properly spread.
Viable alternatives for your investment money? There are plenty to choose from. Current high-yielders include the Halifax Regular Saver account, which pays you 7% over a fixed one-year term. (Or 10% for a Halifax Children’s Regular saver account.) And the National Savings Direct ISA still pays 6.3% tax-free, which is equivalent to well over 10% for a top-rate taxpayer. But if you feel that helping other people to escape the greedy clutches of the lending banks is your way of saying thank you for the success you’ve had in life, a loan to Zopa might well be the way to go.
Action to take: For further information on how to lend and borrow over the internet log on to www.zopa.com
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