Investors in peer to peer lending are not always aware of the types of loans they are investing in on different platforms. Often, investors trust the platform – Viainvest, Zopa, Twino, etc. – rather than make a conscious choice over the types of borrowers they lend to. This article breaks down the different types of loans typically offered on peer to peer lending sites.
Businesses often want to borrow money to finance their ongoing growth. Small to medium sized businesses in particular often struggle to borrow funds at a reasonable rate of interest from the traditional banking sector. Peer to peer lending platforms which offer business finance, such as Funding Circle, can conduct due diligence on the businesses and allow them to raise finance directly from P2P lenders.
Business loans can be huge. Property loans on sites like Lendy are often multi-million pound deals. One recent loan on Lendy was for £11.9million (approx. €13.5 million).
Business Lending: Property Finance
Property loans are almost always secured against the property asset that is being developed or financed. In general, an independent party will value the property. Based upon this valuation, a level of borrowing (Loan-to-Value) can then be made against the asset which covers the capital and accrued interest in the event of a default.
On the one hand of the risk-spectrum, borrowers could be owners of buy-to-let properties which are rented out on a long-term basis. The owners may want to free up capital to invest in further properties and can cover the interest payments within the ongoing rental income. The rates of interest paid out to lenders on some of these products is lower (e.g. 3% – 4% on Landbay in the UK) but the perceived risk of capital loss is also lower.
On the other hand of the risk-spectrum there are very large development projects where the ongoing development is financed by borrowing in various tranches. As the development of the project progresses and the value of the site increases, more funds can be borrowed against the same Loan-to-Value. Once the project is complete, the site is generating an income and the perceived risk is reduced then borrowers will try to refinance to a lower interest rate.
There are also more complex loans, such as those based on 2nd or higher charges, where in the event of a default the 1st charge holder takes priority for all capital and interest repayment. So before investing in these types of loans it’s important to fully understand the terminology used and the corresponding risks involved.
Business Lending: General
Businesses may not have a single large asset such as a property to use as collateral for a loan, but they may still have value in the business and a personal guarantee from the company directors.
Invoice Financing (factoring)
Many businesses operate on a model where they do a piece of work and later invoice their clients for payment. The terms of payment may mean that their client has 30, 60 or sometimes even more days to pay. Invoice financing or ‘factoring’ allows businesses to release funds early from the expected future cashflow from these invoices.
Unlike business loans, consumer loans tend to be smaller and far more numerous. For instance, the average loan issued by VIA SMS Group is €243, a long way from the six or seven figure sums on some business lending platforms. This makes it easier for investors to diversify their investment over a large number of different loans. It also reduces the reputational or platform risk of a single large loan defaulting. Whilst many peer-to-business platforms rely on business assets to cover loss in the event of default, consumer lending platforms often have a provision fund or buyback guarantee subsidised by higher rates of interest.
Consumer borrowers can be accessed via credit rating agencies and their previous borrowing record to help reduce the risk of default. This is cheaper than carrying out in-depth independent property valuations or some of the other due diligence required for much larger and more complex business lending.
Interestingly, consumer lending is far more popular in continental Europe than the UK. The AltiFi index of alternative finance data breaks down the investment split at around 71% Consumer : 19% Business in Continental Europe as opposed to a 36% Consumer : 63% Business + Invoice Financing split in the UK.
Short Term Lending
Perhaps the most well-known form of short term lending is the ‘payday loan’, where borrowers need to borrow a small amount to manage short term cashflow. Whilst the annualised rates of interest can be very high, as loan terms are typically short the actual cost to the borrower is hopefully manageable.
Other Types of Consumer Lending
Consumers often borrow for large one-off purchases such as car finance, home improvement or even weddings. Borrowers are willing to trade-off a higher total cost with interest included for the convenience of an up-front purchase.