All investing carries risk. To novice, fairly experienced and sophisticated investors alike it is extremely important that all investments are perceived with some degree of “risk” – it is the investor and the peer-to-peer lending platform’s (P2P) duty to assess and inform on risk before funds are invested (lent out) and higher than average interest rates can be achieved.
In financial climates, where markets can dip, interest rates fluctuate and economies rise and fall, investing your money will never really be a “safe bet”. If you want to receive returns in the region 3-19% avg interest earned annually, then you need to be prepared to take some educated risks. Peer-to-peer lending is the fastest growing financial product on the market just now. The industry is expanding exponentially, but responsibility when investing is a must.
All major peer-to-peer lenders have the same agenda: lend money effectively. Transparency is pivotal therefore, ensuring investors know who they are lending to, how the loan is structured, the mechanics of their repayment and, most importantly, the risks with investing.
Here are some key risks and the mitigating procedures implemented by UK P2P Lenders:
The biggest risk is borrowers not repaying their debt, including interest.
Borrowers are vetted prior to being allocated a loan. All major P2P lenders enforce strict lending criteria, including credit checks, to minimize the likelihood of a borrower defaulting on their loan repayment.
An auto-bid function exists amongst P2P lending platforms, where your funds are automatically split across numerous borrowers, spreading the risk of default. Several major platforms allow you to automatically split your investment; RateSetter and Zopa spread between circa 100 borrowers per investment. Assetz Capital, Rebuilding Society, Proplend and Saving Stream include the option to manually select your loans. This is riskier and you may not have coverage from their provision funds.
Some P2P lenders operate a ‘Provision Fund’ which takes a small % of the loan repayment – as paid by the borrower – and stores it in case you qualify for coverage should a borrower not meet a loan repayment. Funds pay out at the discretion of the platform’s directors usually.
Many major peer-to-peer platforms will take some form of personal guarantee, or asset backed security, the value of which must exceed the requested loan amount, E.G: buy-to-let property loan made via Landbay would be granted up to 65% value of the borrower’s property, ensuring the asset can be sold to cover repayments should the borrower default.
The peer-to-peer lender that you invest in ceases trading.
If a P2P lender ceases trading, precautionary steps laid out will be followed, but each platform will vary. Wellesley & Co for example hold borrower security in an independent security trustee. At insolvency, a Security Trustee will come in and run the day-to-day operations ensuring the platform can still run and investors receive their repayments.
Whether it’s property or SME business loans, if the market takes a dip it will likely affect the borrower’s ability to pay back their loan. Take loans that are secured by property for example: if the UK property market crashes the borrower’s ability to repay their loan will likely be affected.
Again, the Provision Fund may be able to come to the rescue. Major P2P lenders store funds in a fund that can be accessed if you qualify for compensations should a borrower default on their repayment. If the fund is oversubscribed or of insufficient size to cover repayments, P2P platforms may choose alternate methods to cover losses.
While not a threat to capital and interest repayments, interest rates may fluctuate whilst your funds are lent out. This means you may not receive potentially higher rates on offer, as the funds will earn the interest rate offered at the beginning of the ‘loan term’.
For short loan terms, investors may not need to wait long until their funds mature, at which point they can reinvest in a product at a higher rate. Also, many peer-to-peer lenders offer early access allowing funds to be withdrawn, which again will allow an investor to reinvest at a higher rate – P2P lenders vary with their early access process. If you want to ‘Sell-Out’ of your investment entirely, you must enquire with the platform as they will work to sell this to a new investor, assuming one is available.
In peer-to-peer lending there is no coverage by the FSCS (Financial Services Compensation Scheme). You could lose your money and be unable to make a claim with this compensation scheme.
Peer-to-peer lending is regulated by the FCA (Financial Conduct Authority). All P2P lenders must pass a rigorous, in-depth application process to be authorized and regulated by the FCA so they can hold deposits and lend money.
Most major lending platforms do a good job of presenting information clearly, stipulating risks and ensuring their customers are comfortable in their investment decisions. If a P2P platform isn’t being as transparent as the FCA deem they should, they can be sanctioned and heavily fined.