Is it too good to be true? - The rise of the 4% plus savings accounts

05th February 2015

“More interesting savings”, it says, but Wellesley & Co’s new TV advertising campaign could be misconstrued; suggesting that you could earn 4% or more in a savings account in the current market seems too good to be true, doesn’t it?

Wellesley & Co, like many others, is not your traditional high street bank but rather a Peer to Peer lending firm. This firm links investors with borrowers and charges an interest rate, effectively cutting out the middle man or in this case, the high street bank. The confusion comes as some products are pitched as savings accounts, which they’re not. They are more akin to an investment and do come with some risks. Should a borrower default you may not receive the published rate of interest. Worse still, should the Peer to Peer lender go into administration you may not get back anything at all.

There are a growing number of Peer to Peer and Crowdfunding companies popping up, many no doubt capitalising on the current low interest rates payable on traditional savings accounts. It’s probably therefore no surprise that Peer to Peer lending totalled £1.3 billion in 2014 alone, which is a fairly large amount considering it’s only really come to popularity in the last few years.

This figure is still a drop in the ocean however; there is over a trillion pounds held in traditional savings accounts in the UK.

Certainly the major Peer to Peer lending firms mitigate risks by spreading money between a numbers of borrowers. But the key point is that there is a risk, more risk than within a traditional savings account.

However with more and more providers offering eye watering ‘savings’ rates it’s fair to assume that some savers may be unware of what they’re signing up to and could be lured in under false pretences. Risk adverse savers may be unaware that these are not savings accounts at all, but are in fact investments. Although you may feel like you’re opening a deposit account, the rates aren’t guaranteed and the capital isn’t secure. 

Traditional savings accounts from a Bank or Building Society are regulated by the Financial Conduct Authority and covered by the Financial Services Compensation Scheme (FSCS), which guarantees to protect savers up to £85,000 per person, per banking licence. Although Peer to Peer lenders are regulated by the Financial Services Authority (FCA), they are not protected to the same degree as Banks and Building Society savers through the FSCS as mentioned above. FSCS does not cover peer to peer lending.

It’s worth noting that the FSCS cover on Bank or Building Society deposits is not always completely straightforward as some providers share a banking licence, so you need to check you are fully covered by all of your savings providers. However, done correctly, very few savers would struggle to fully protect their whole savings balance and can certainly minimise risk.

That’s the beauty of a traditional savings accounts. Although in the current shockingly low interest rate environment many savers may see little benefit in saving, there are few vehicles that offer the same security as a traditional savings account.

Which is why, financial advisers and pundits all agree that we should ALL hold money in cash for emergencies or perhaps building up a deposit to buy a property. It may be challenging with low interest rates to see the benefit of opting for cash, but if you’re risk adverse, it’s the safest option.

What we know is that currently, Banks and Building Societies are doing very little to encourage us to save more in the form of better interest rates and this gives rise to the popularity of Peer to Peer or similar firms.

Many savers, disillusioned with the current record low interest rates on standard Bank and Building Society savings accounts, could be tempted to opt for one of these investments. But savers must be fully aware of the risks involved. 

When the Bank of England base rate hit its record low of 0.50% almost six years ago, little did we know just how bad things would get. The introduction of the Government's Funding for Lending Scheme back in 2012, killed competition in the savings market by giving providers access to cheap funds to lend. Banks and Building Societies almost immediately began reducing the rates on offer to savers and so then began a domino effect to new and existing savings rates, so much so that still every week rates on savings are being reduced.

It’s understandable therefore that many savers will be desperate for a decent return on their cash. Those savers, especially pensioners, who rely on their savings income, may have all but given up with little option to better their returns. Look at the recent success of the long awaited 65+ Guaranteed Growth Bonds (dubbed Pensioner Bonds) from NS&I, paying up to 4% gross/AER. The website crashed on launch day and the phone lines were constantly engaged – this highlights just how desperate savers are for a competitive interest rate on their cash.

It’s encouraging therefore that the Financial Conduct Authority (FCA) is reviewing how Crowdfunding and Peer to Peer products are promoted. Given the sky high interest rates being published it’s easy to understand how savers, disillusioned with traditional savings rates, could be tempted into products they don’t fully understand or believe are in fact savings accounts.

We don’t advise on the merits of Peer to Peer or Crowdfunding products including their suitability, because they’re NOT traditional savings accounts. But we’ve put together a brief summary to explain how they work, without the sales pitch.

What is Peer to Peer?
Peer to Peers works by effectively cutting out the middle man, or in this case the financial institutions (Banks and Building Societies). They match borrowers with lenders (savers) offering in many cases competitive rates of interest. Although many Peer to Peer lenders will distribute loans among a number of borrowers, to mitigate the risks, there is still a risk and so the rates on offer are not guaranteed and you could get back less than you invested.

Although some firms have set up provisional funds for borrower defaults, they are not covered by the FSCS and so money is not guaranteed or protected.

What is Crowdfunding?
Crowdfunding works whereby a company offers to pay a competitive rate of interest for those willing to invest in a venture such as a start-up business. The interest you receive ultimately depends on how the business grows and how profitable it becomes over the time you are invested.

Again, firms are not covered by the FSCS and so money is not guaranteed or protected.

We don’t advise on peer to peer lending however we are able to talk to you about your savings requirements and where appropriate to provide a recommendation to a Chartered Independent Financial Adviser. Call us on 0800 321 3581.

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