Not Checking Loan Originators
What to Look for
Not all lenders are created equally. Before jumping on the bandwagon, all P2P investors should check:
- Lender rating, if available
- Track record – how long have the lender been in business
- Default rate – how many of the lender’s customers fail to pay back their loans
- Lender’s skin in the game – how much of the lender’s funds are invested in each loan
- Buy-back offering – does the lender buy back defaulted loans
The biggest risk for lenders is borrowers who won’t pay back their loans. An effective loan approval process is therefore a key factor to a successful loan portfolio. With a highly competitive market for short consumer loans and increasing interest in P2P lending, some lenders are likely to relax lending terms and take higher risks.
P2P platforms like Mintos rate their loan originators, which is of great help to new P2P investors. Other platforms, like FastInvest, don’t reveal their loan originators at all. Which is your more likely to trust?
Track records and financial information about loan originators are very useful when you start P2P investing. Check them regularly, at least once a year. The more data a lender publishes on its lending business, the better. Be aware of lenders who just keep old data online and aren’t fully transparent.
Not Checking Guarantees and Collateral
Understand the Difference between Secured and Unsecured Loans
If a loan is secured against an asset the borrower owns, the risk of default is less. Secured loans are often used to borrow large sums of money for housing or business projects. Envestio and EstateGuru are two P2P platforms that offer secured loans.
Most consumer loans, however, are unsecured. Because the loans aren’t secured, the interest rates also tend to be higher. You could say that higher-risk lending also means higher rates, but not necessarily higher returns.
Because higher risk also means higher default rates (more borrowers won’t be able to pay back their loans).
When an individual or a business defaults, the lender has some recourse to reclaim the funds, but it varies based on the type of loan and country regulations. Some loans will end up as bad debts – loans that aren’t possible to recover. It’s a loss to the lending company – and possibly to you as an investor.
Should You Worry about the Default Rate?
Is it necessary to keep an eye on the default rate when the loan originator offers a buy-back guarantee?
The short answer is: yes!
Skin-in-the-game and buy-back guarantees mean that the lender is using own funds to invest in loans and to compensate investors for default loans, including bad debts. Too many bad debts and the funds may dry up quickly. Which, eventually, may result in bankruptcy.
High default rates may also indicate relaxed lending terms and a high level of risk-taking by a lender.
P2P investing platforms, as well as loan originators, report default rates and bad debts differently and sometimes not at all. Steer away if you find reporting unsatisfactory.
You should also be aware that default rates aren’t constant, they change with the economic climate. Increasing unemployment in a country almost automatically results in higher default rates. Just to mention one factor.
If the default rate is higher than 15% you should use caution when investing. Look for rising defaults combined with sinking interest rates and new fees. It may indicate that the lender is in trouble.
Remember, it is difficult to draw conclusions from your own portfolio, since it’s just a small portion of the lenders total loan stock. But when more than 25% of your re-payments are delayed, you should keep an eye on your investments.
If the P2P platform only have old information about the loan originator (see below where information is almost 3 years old), you should start asking questions.
Check the Buy-Back Guarantee
To avoid losing money on investments, P2P investors should look for a buy-back guarantee.
Loans without the buy-back guarantee have higher interest rates. You may earn more, but you also take a higher risk. Since you can’t affect the loan approval process and have minimal information about the borrower, this risk may be too high. This is especially true when the loan isn’t secured against an asset.
If there is a buy-back guarantee, check if it includes both principal and interest? When a buy-back guarantee only includes principal, you lose interest on invested money before the guarantee kicks in (usually 60 days).
If 10% of your loans defaults and remain idle on your account, calculate your returns accordingly. An annual return of 8% may end up at 7.2% or less, as an example.
Immediately Allocating All Funds to Auto-Invest
How to Use the Auto-Invest Tool
Most P2P platforms for personal loans come with an auto-invest feature, and most P2P investors use it. It’s perfect for investors who want a worry-free passive income.
After you have set your preferences for investments and re-investments, the auto-invest tool allocates your funds in different loans – while you are busy doing other things. Some tools have many filtering options for your preferences, others have less.
Start by filtering the current loan list with your preferences. Does the filtered list give you loans that you are ready to invest in? If so, allocate a smaller sum of your total funds to an auto-invest portfolio. Evaluate the portfolio after it has been fully or partially invested.
It can be a good idea to keep only short-term loans in your first portfolio. If something goes wrong, you don’t want your money locked in for long terms.
Diversity to Keep Money Safer
Larger P2P platforms offer loans from several loan originators and different countries. To lower risks, the smart P2P investor spread funds across lenders and countries. Perhaps even currencies. You can do this by creating different portfolios within the auto-invest tool.
Follow up on a regular basis to make sure you have the kind of diversity you want.
If your initial platform doesn’t have that kind of diversity, consider spreading your money to different P2P platforms. Many P2P investors use 3 or 4 different platforms for their investments.
Disclaimer: Article may contain sponsored links, but all views are by our staff members after investing in different platforms and they stay unbiased.