Crowd-lending and peer-to-peer lexicon
This lexicon will explain the terms you’ll most commonly encounter when investing in loans. Several definitions are borrowed from external sources, while I wrote other ones.
Crowd-lending is the use of small amounts of capital from a large number of individuals to finance a new business venture (adapted from Investopedia).
Usually, crowd-lending will apply to real-estate projects or industrial projects.
See also : Peer-to-peer lending
Peer-to-peer lending (P2P lending)
Peer-to-peer lending is a method of debt financing that enables individuals to borrow and lend money without the use of an official financial institution as an intermediary. Peer-to-peer lending removes the middleman from the process, but it also involves more time, effort and risk than the general brick-and-mortar lending scenarios. (Investopedia)
See also : crowd-lending
Refers to investing in loans directly through a platform; mostP2P lending and crowd-lending loans in your portfolio will be bought this way.
See also : secondary market
The secondary market is a market place allowing investors to sell loans they own to other investors. It helps make the loans market more liquid.
Note that while the use of secondary market itself is usually free, they loans will usually have to be sold at a discount, especially if their credit rating is poor or if the borrower is late in her/his payments.
Also note that not all platforms offer such a feature. A special case is Envestio; there’s no secondary market, but the company will buy back your loans for a fee.
See also : primary market
A loan originator is the firm that originally provides the loan to the borrower. They usually lend a small percent of the amount using their own funds (typically 5%-10%); this is called skin in the game and is supposed to encourage originators to provide quality loans. The remaining part of the loan is then sold to investors through marketplaces.
The financial equivalent of not putting all your eggs in the same basket. Diversification can happen at several levels :
- investing in many small loans rather than a large one
- investing in several loans kinds
- buying loans issued by different originators[?]
- using different platforms
The credit rating is provided by originators; it allows investors to judge how trustworthy a borrower is. Borrower with better credit ratings will typically pay lower interest rates than those with a poor rating.
Manual investing is the act of selecting a portfolio’s loans manually. This method is generally used for real-estate crowdfunding, where the risk of each project has to be evaluated individually. Peer-to-peer loans are usually more standard, and can be investing in through auto-invest.
See also : auto-invest
Auto-invest is a tool provided by most platforms; it allows the investor to define the characteristics of the loans she/he wants to invest in, and let the system choose the individual loans based on these criteria. Auto-invest allows the investor to save time, and makes it much easier to diversify a loans portfolio by investing in a large number of loans.
A buyback guarantee is a guarantee provided by a loan originator regarding a specific loan. If repayment of that particular loan is delayed by more than a specified number of days (usually 60), then the loan originator is obligated to buy back the loan. (MoneyBrewer)
It’s important to realize that this guarantee is not absolute; if the originator bankrupts, it obviously won’t be able to repurchase the loan, leading to a loss for the investor if the borrower defaults.
Loans marketplaces may run cashback campaigns; they will return a small amount (usually 1%) of the investment on selected loans. The criteria will vary; it may be for long-term loans only, or for a specific originator.
LTV (Loan-To-Value ratio)
The loan-to-value ratio (LTV ratio) is a lending risk assessment ratio that financial institutions and others lenders examine before approving a mortgage. Typically, assessments with high LTV ratios are generally seen as higher risk and, therefore, if the mortgage is approved, the loan generally costs the borrower more to borrow. (Investopedia)
As an investor, you’ll only mostly with LTV when investing in real-estate crowd-lending projects.