Guest Blog - Peer To Peer Lending - worthy of consideration in an environment of low interest rates and rich stockmarket valuations?
My mate Phil Sloan has very kindly contributed the Guest Blog underneath to explain in simple terms to us all the Ins and Outs of Peer-to-Peer stuff. As he says in the text, he was looking for alternative forms of Income with Bonds and suchlike being such poor yielders and this drove him to do a huge amount of digging into P2P and we can now benefit from his endeavours.
If you have been following me on Twitter and partaking of the Website for some time you will know that I am pretty cautious on the whole P2P ‘thing’ with my main reservation being that most of the Providers sprung up after the 2008 Credit Crunch and we are yet to see how they will behave in a Recession and/or tougher times (having said that, I have just learnt from Phil‘s text that Zopa actually kicked off in 2005). For this reason, I would take the view that it is best to stick to the more well-known, established, names and in-depth research and investigation is essential. Of course it makes good sense also to limit exposure to this area and probably any more than 15-20% or so of a Portfolio might be taking on quite a bit of Risk - at least until you’re used to how it all works and after having more experience of how these things work over the business cycle. Phil has a good section on the Risk side of things and spreading things across Platforms etc.
Near the bottom of the Blog you will find Phil has included some ‘Cashback’ Deals from a few of the larger Providers - if you fancy going for one of these then Phil will get a payment from them (I guess like some sort of Introductory Fee) and Phil has agreed to share any that come back with me - so that will help my Beer Fund !!
Please note neither Phil nor myself are ‘Financial Advisers’ or anything like that and we are not giving Advice. Please read the Disclaimer on my Homepage and make sure you seek appropriate Financial Advice.
Right, enough of my waffle, hope you find it useful - oh, and Phil can be contacted on Twitter as @sloan_phil or by email on firstname.lastname@example.org
Probably like many readers of Wheelie's excellent website, much of my time, effort and money is invested in the stock market. In my particular case, I'm increasingly reliant on share dividends to pay my bills, so currently three quarters of my total wealth is invested across stocks and shares. However, with markets currently at all time highs, valuations stretched (in both shares and bonds) and many unknowns including Brexit, European elections, Trump and potential interest rate rises looming, I've felt increasingly uneasy about having 'all my eggs in one basket'.
My unease has been compounded over the last year or so by savings rates being regularly punished by banks and building societies, to the point where you're now meant to feel grateful for receiving 0.85% p.a interest!
So last summer I started to look for an income alternative to diversify into and after quite a bit of research decided to dive into the 'murky world' (as the media would have you believe!) of Peer to Peer (P2P) Lending.
Since my first tentative investment with Ratesetter last July, I now have approx 12% of my total resources in the sector, and I'll probably look to increase that level to about 20% over the next 12 months, as I empty the remaining pennies from the majority of my savings accounts.
So in this little post, I thought I'd try and highlight some of the pros and cons of P2P lending, as there are some very attractive yields/rates on offer, many of which are secured against conservatively valued assets.
What is Peer 2 Peer Lending (P2P)?
In its simplest form P2P lending is about cutting out the middle man (in this case those dastardly banks!) and matching up borrowers with private lenders. The first platform to do this, Zopa, opened for business in 2005, and over the proceeding years many new platforms have followed suit, offering ever more inventive ways of lending money.
There are many different types of borrowers including consumer, property developers and small and medium enterprises (SME's). They look to borrow at an agreed rate of interest (usually lower than banks are willing to lend at) and for an agreed length of term.
Since Zopa first matched up individuals over a decade ago, P2P has gone from strength to strength. Figures just published show that in 2016 over £3 billion was lent out in the UK alone, an increase of 67% on the previous year and bringing the cumulative total up to £7.3 billion…..And the growth isn't set to end there either, Deloitte predicting the UK P2P market could be worth approximately £35 billion by 2025.
Dispelling the Myths of P2P Lending
As a whole the P2P industry continues to develop strongly and many platforms are now either in the final stages of obtaining, or already have obtained, full FCA authorisation such as Lending Works, Landbay & Abundance. Abundance has gone one step further and even now offers an IFISA (Innovative Finance ISA), others will follow suit this year.
Despite all this progress, the industry has certainly received its fair share of bad press (in fact it's the main reason I didn't invest here much sooner!), but hey, it's probably in the banks & building societies interests for it to be that way, I guess?! Especially when you consider it’s possible to make more interest in 1 month on some P2P platforms, than most current and savings accounts are now paying in a year!
Now before you cry, “yes, but P2P Lending is so much more risky“, I'll try to illustrate how there are varying degrees of risk (just like in the Stock Market!) and that it's still possible to take home a very nice level of monthly interest from P2P against loans, secured against good assets, at reasonable loan-to-value (LTV) ratios.
Diversification is key - across both loans and platform
"So, if I was interested in investing in P2P, how should I go about it?"
Diversification of Loan type
Just like the stock market, its unwise to put all your eggs in one basket, i.e. all in one loan, or even all your funds in one platform.
There are a variety of different types of loans available such as: Residential & Commercial Property Development, Jewellery/Pawn, Cars, Art/Collectibles, Consumer Loans, Invoice/Balance Sheet Financing, Buy-to-Let mortgages, Renewables etc. etc.
Loans are either unsecured (heightening the risk!) or secured against the asset. In the event of default on a secured loan, the platform should acquire control of the asset, and then look to sell it on your behalf, in an attempt to recover as much of your capital and interest as possible (if not all of it).
The assessment of a loan is probably worthy of an article on its own, but only necessary if you opt for the more active investment route. The types of things to consider would include: the security of the loan, the loan to value ratio (LTV), the duration, the quality of the borrower (if known), whether or not the repayment proposal is realistic and viable, and the interest rate and payment schedule.
Diversification of Platform
Being such a young industry, many P2P companies have relatively short trading histories. Whilst more and more platforms are now receiving full FCA authorisation, unlike banks, none are covered by the Financial Services Compensation Scheme (FSCS). In most cases contracts are drawn up between borrower and lender for each loan, so that were a platform to go bust, the contracts would still exist and be passed on to an administrator to oversee (in theory at least!). No major platform has actually gone bust in the UK yet (fingers crossed that continues!), so the proof is in the pudding, but my strategy is to spread my money across platforms so if any platform does go to the wall not too much of my money is tied up waiting to be recovered. Consequently I've now got my investments spread across nearly a dozen platforms.
Passive P2P platforms
Passive investment platforms such as Zopa, Ratesetter and Lending Works are the most popular P2P platforms, and are probably the way to go if you're looking to get a foothold in P2P. Basically, you give them your money and they match you up with borrowers, giving you micro-parts of numerous loans, automatically spreading your risk for you. These 3 platforms also operate ring-fenced provision funds, intended to cover any losses in the event of any defaults (as the loans on these platforms are typically unsecured, consumer). Interest rates on these platforms are now relatively low (typically between 3 - 7%), but crucially there are Cashback and welcome bonuses available, which can boost your returns in the first year to approaching 10%.
If you are interested in investing in any of these platforms, please be sure to see the Cashback section (towards the end of the article), and use the relevant link to ensure you receive the bonuses.
Active Investment Platforms
Like anything, if you're prepared to put a bit of graft into it, you tend to receive better rewards, and so it is with P2P Lending. The majority of my funds are in 'hands-on' or actively managed platforms where the broker brings the borrowers to the table, having already agreed terms such as interest rate, length of contract and security. It's down to you then to do your own due diligence to decide whether or not to lend to them, and if so how much to allocate. On these type of platforms, interest rates of up to 14% are typically available, though I'd say 10-12% is a reasonable (and safer!) target.
I proactively manage these funds, turning over my loans regularly, keeping things 'fresh', just as you might with a share portfolio. An active secondary market allows the quick sale of loans, if you wish to terminate before the end of the term (something I always like to do, as it removes the risk of holding at that critical moment, when the borrower's due to repay!!).
Two of my favourite Active Investment Platforms are:
Crowd-funding platforms - a niche within a niche
Over the years the boundaries of what is and isn't P2P have blurred, but there are one or two interesting sub-sectors worthy of mention. Property Crowd-funding is one such example. Here, platforms such as Property Partner or Property Moose identify properties suitable for buy-to-let and put in an offer to purchase (usually at a discount to market value). They then look to raise the cash to purchase by offering it to its lenders, who effectively take an equity stake in the property. Once raised, the platform then secures the property and looks to rent it out to a tenant (in some cases they even come with tenants already in situ!). Monthly rents are collected and then divvied up amongst the lenders, who receive their share as an interest payment.
Typically the properties are bought with the intention of holding for 3-5 years, collecting monthly rents along the way, before (hopefully!) selling on at a profit and realising a capital gain.
Basically, its a really neat way of being a passive landlord, without all the associated niggles and hassles that usually go with running a buy-to-let. Also, it allows those who don't have enough cash to buy and run their own buy-to-lets outright to still be involved in the buy-to-let market.
Net yields aren't too shabby either. I'm averaging about 3.7% on Property Partner, and around 5.8% on Property Moose, which has a northern bias, where yields are typically higher. Cashback deals are also usually available here too, in what I feel is a pretty novel way of diversifying away from the stock market.
I'm not going to deny that, just like the stock Market, the P2P industry wouldn’t be susceptible to a downturn in the wider economy or a 'hard Brexit'. However, if there is good liquidity in your platform, or a good Secondary market, you may well be able to sell your investments prior to the end of the loan term, should you so wish. As with the stockmarket, it’s an investors responsibility to monitor events and news and take the appropriate action if necessary.
For this reason, the majority of my P2P funds are now in active investment platforms such as Moneything & Collateral, where I prefer to invest in loans that are secured conservatively against the asset (whether it be property, machinery, cars or jewellery). In this case the loan-to-value ratio (LTV) is key - the lower the better, as it gives you more wiggle room in the event of a default! Also in my experience its best to always go for loans that have first charge on the asset in question (i.e. should the borrower default, you are first in line, once proceeds are divided up after a sale, which the broker would typically handle). I'd avoid loans with second charges and certainly ones with just personal guarantees.
If all this sounds a little too much like hassle, you could go the way of the majority of P2P lenders; the passive investment route via the likes of Zopa & Ratesetter. There is certainly some merit in having some money here too, especially whilst you find your feet in the sector. As previously mentioned these firms tend to have longer trading histories and have separate provision/reserve funds, which can be called upon in the event of any default. Not forgetting the Cashback deals that can bolster first year returns.
'So what's the deal, on these Cashback deals?', I hear you say?
One neat aspect of the need to diversify, is the proliferation of new customer deals (through referral schemes and welcome bonuses) that are currently on offer in this still relatively new industry. Sites offer cash payments of £50-£100 for joining and investing in as little as £1000, so when you add in the loan interest that your £1000 would also generate, you can achieve returns of 10%+ in some cases - something I'd be happy enough achieving in the stock market most years!
All in all, they offer any new investor a great way to enter the P2P market and mitigate against a fair bit of the risk involved of any potential defaults.
Current Cashback Deals:
Please note, to ensure that you receive the Cashback deal on offer, it's important that you use the links directly below when you're ready to register (though obviously you are free to browse their website beforehand, please come back to this link if/when you decide to join):
To conclude, P2P Lending is a rapidly growing and exciting area to invest. However it's also complex and like the stockmarket does come with risks, though hopefully this post goes some way to explaining how to protect yourself and skew the odds in your favour. With a balanced, diversified P2P portfolio, spread across a variety of platforms and loan types, I believe it is possible to achieve returns that will compliment your Stockmarket portfolio rather nicely.
Thanks for reading and happy lending!
As you can probably see by now, P2P is a complex and exciting area of finance, and I have really only scratched the surface in this post. If you wish to do further reading, the links below should be of use:
NB. This article does not constitute advice. As with any sort of investment please do your own research.
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