I see the peer-to-peer pioneer Zopa has evolved again, with the company introducing “Safeguard”, a new and arguably safer way to lend money.
Hitherto Zopa has worked by matching individual lenders and borrowers in a marketplace. You set the interest rate you’ll accept on your loans, and Zopa pairs your savings up with borrowers (or vice versa).
The main benefit of lending via Zopa has been higher rates than you’d get with a bank. Some people also liked the idea of lending direct to individuals, and cutting out those “greedy” financial institutions.
The downside of Zopa was if a loan soured and your smiling borrower turned into a feckless defaulter, then you lost most or all of the money that you’d lent them.
The default option
Your main protection against default has hitherto been Zopa’s usually excellent credit checking, which has kept bad debt well below the predicted levels (though I suffered when it seemingly went on the blink for a month a few years ago).
In addition, you can spread your money between very many borrowers – perhaps lending as little as £10 to any one individual – in order to reduce the impact of any single borrower doing a runner to Gibraltar.
With a fairly large pot of money and typical luck, you could enjoy a healthy average annual return, after deducting fees and bad debts.
Money lent with Zopa is not guaranteed by the Financial Services Compensation Scheme (FSCS) however, and defaults can and do happen, with cash-sapping results. And just to add insult to injury, the way that Zopa interest is taxed, you’re unable to set these bad loans off against your taxable interest income.
So bad debts didn’t even give you the small mercy of a slightly lower tax bill for your troubles.
Bailing out your DIY bank
Zopa’s new ‘Safeguard’ option radically changes this traditional Zopa model, if we can use the word traditional about a seven-year old service!
First and foremost, Zopa claims you will be reimbursed if any of your loans go sour. This will be done via a special fund held in trust for the sole purpose of returning money owed to savers if their borrowers default.
At a stroke, the bad debt problem largely goes away (at least so long as the compensation fund isn’t overwhelmed by bad loans due to some sort of unlikely systemic failure).
The second big change with Safeguard is that if you lend money via the new system, you no longer set a rate you’ll accept for your money.
Instead, all the money goes into the one Safeguard pot that Zopa bundles up to create loans for new borrowers. For some reason this Safeguard money has been prioritised by Zopa for lending, too, so you should see it lent out very quickly.
The interest rate you get for each microloan via Safeguard is determined by a changing tracker rate.
Zopa says it will adjust this rate by looking at:
- The rates being set in its own market
- The rates competitors charge for loans
- Average savings rates
You’ll likely get different rates across the micro-loans you parcel out via Safeguard. Overall though, your average rate should be in line with what Zopa is predicting – which as I type is 5.1% for shorter term loans.1
The advantage should be that Zopa will be able to fulfil loans more quickly, especially larger loans. This may enable Zopa to feature more prominently on financial comparison tables for a wider range of loan bands, and so drive more borrowers to the Zopa site.
Currently Zopa has a problem where it seems to have a lot of savers but perhaps too few borrowers, considering how competitive it should be given the cheaper loans it usually offers.
You don’t get something for nothing
The immediate disadvantage of using Safeguard is you no longer have any control over the rate you get.
Also, as I see it the rates on offer via Safeguard will likely be lower than might have been available in the usual Zopa market for two reasons:
- Firstly, some of your return goes to fund Safeguard’s reimbursement war chest
- Secondly, bank interest rates are lower than you’ve been able to get via Zopa, and the Safeguard tracker rate will follow them down
I think there are likely to be long-term consequences from this shift in the peer-to-peer model, too.
Experimenting with Safeguard
On the face of it, the introduction of Safeguard is good news from Zopa.
It’s always annoying when disproportionate bad luck means an overall poor result, so spreading bad debt across an entire constituency of savers – just as you do when you put money into a normal bank – will be welcomed by all but the most masochistic.
However as my last sentence implies, this move also makes Zopa more like a standard bank in my opinion – only without the nailed-on guarantee on your savings from the FSCS (Cyprus-style deposit raids notwithstanding!)
Safeguard represents more of a fire-and-forget approach to lending money. If it becomes the usual way to lend with Zopa, then this will hit those who’ve enjoyed ‘gaming’ Zopa for an extra 1-2% in interest. I suspect it will also reduce the community feel over time, too.
As an experiment I’ve shifted some of my Zopa savings to a Safeguard offer to target shorter-term loans, and the money is being lent out very rapidly. A third of it has been lent out in barely two hours!
Lending via Safeguard is trivially easy:
Against my expectations, the rate I’m receiving today for most of the latest micro-loans I’m making via Safeguard is actually higher than I was getting yesterday in the normal Zopa marketplace
I wonder though if this is just because the pool of money sitting in the Safeguard pot is still relatively small.
Safety first at Zopa?
It’s anyone’s guess, but I expect Safeguard to eventually become the main method of lending money via Zopa.
Having any bad debts repaid will be just too attractive for most people to resist, even if theoretically they might have done slightly better taking the odd hit but getting higher rates to compensate.
Zopa has been getting simpler and simpler (dare I say dumbing down?) for years. It scrapped its high-risk “C” marketplace and its “Y market” that provided loans to young people, for instance, and it reduced the term options for lenders to “shorter” and “longer”, in place of specific terms measured in years.
I didn’t find those changes detrimental, personally, but the result was undeniably a simpler product.
Some changes have been wholly for the good, especially the “Rapid Return” facility that now enables you to get much of your savings money out at short notice if needed, albeit for a charge. Rapid Return partially addressed the imbalance whereby borrowers could repay early, but lenders had to remain locked into their loans.
I think the new Safeguard product will also prove popular with all but the hardcore, but I wonder where it will end.
It will likely suck more savings into the system, and it will likely bring down rates for those borrowers who find their way to Zopa, too.
But arguably Zopa’s problem is one of insufficient scale, which means any emerging imbalances have tended to be addressed by shifts in its operating model.
In theory, its original market-driven rate-setting system should have produced the perfect equilibrium between risk and reward.
But with Safeguard’s tracker rates partly set by competitors and Safeguard savers having to take what they’re given by way of return, the lofty ideals of the early peer-to-peer enthusiasts seem to be further away than ever.
- For all the ins-and-outs about Safeguard, visit the Zopa website.
- Note though that as an early adopter I am only paying a 0.5% lending fee. New lenders will pay a 1% fee, which will reduce this predicted rate by another 0.5%.