A large variety of loans kinds to choose from
Determining your investor’s profile is the most critical decision when investing in loans. This page aims at listing the different options you have.
Note that you’re in no way limited to one kind of loans. As a beginner, it’s more manageable to start by investing through just one platform. However, as you’ll gain more experience, a well-thought diversification can at the same time enhance your crowd-lending portfolio’s returns and lower the risk !
The three main aspects of a loan that will influence risk are :
- the presence of a buyback guarantee
- the duration of the loan
- the kind of loan : individual, business or real-estate
Buyback or not ? The most critical aspect of your investor’s profile
That’s the first consideration, and probably the most important one. A buyback mechanism means that if the borrower fails to reimburse in a timely fashion, the originator will purchase back the delinquent loan. The delays is usually 30 days, sometimes 60. Without such a guarantee, you may lose the whole remaining loan’s capital if the borrower defaults !
The buyback guarantee will of course always cover the principal (or part of it), but it may even cover the interests. It’s important to check the details for each platform as they usually vary.
Most websites will display a shield icon for loans covered by this guarantee.
In addition to this standard buyback mechanism, there are two variations :
- “Payment guarantee”, which guarantees the payment of interests on time. It’s a rare feature and only marginally influences the returns.
- Partial buyback, reimbursing only a given percent of the outstanding capital.
Of course, loans covered by a buyback guarantee are those considered as safest, and thus they usually offer a lower interest rate than non-guaranteed loans.
Buyback guarantee used to be only available for individual loans; real-estate crow-lending and business loans usually didn’t come with such a feature. However, things have changed for the better and several platforms now offer a buyback guarantee for these loans.
The term “secured loan” is often used for loans covered by the buyback guarantee, as opposed to “unsecured loan” for loans without such guarantee.
Types of loans offered by P2P lending platforms
There are basically three kinds of loans available : individual loans, business loans and real-estate loans. Deciding in which loan category to invest is the third component of your investor’s profile; like the two previous criteria, it will influence the risk level (and thus the returns) of your crowd-lending portfolio.
Individual loans and small business loans
The most obvious way to invest in loans is through individual loans secured by a buyback guarantee; these are available for durations from one month to several years. Most P2P lending platforms provide such loans with a buyback guarantee, which makes them very safe – although of course not 100% safe -.
Individual loans may be sub-divided into payday loans, car loans, home improvement loans… The loan kind will mostly influence its amount and duration.
Should you choose to invest in individual loans without a buyback guarantee, you may have to pay attention to the loan kind. Indeed, loans used to buy a car or a house may provide a better safety, at the cost of a lower interest rate : the bought item is used as a collateral, and may be resold if the borrower defaults.
Professional loans for small amounts will often be available on the same platforms as individual loans. They may be more risky, though, so the buyback guarantee seldom applies to them.
Invoice finance is a specific business model dealing with professional loans. In this case, the loan is used to provide advance payment of an invoice which will be paid later (usually 1-2 months later). There are platforms dedicated to invoice finance, but these loans can also be found on generic platforms.
Large business loans
Loans requiring large amounts of capital will be found on dedicated platforms. They will commonly be used by businesses requiring to fund business expansion. These loans can be highly speculative, yielding great returns – with a matching risk level, of course –
Real estate crowdfunding
Large amounts of money are usually involved, and the returns may be more uncertain, as is any real estate-related investment. Moreover, many these investments may not pay interests monthly, but rather once the project is completed. That’s another point to keep in mind if you’re looking for a regular income source.
Loans durations usually depend on their kind. Some peer-to-peer platforms specialize in short-term loans, while other offer loans for a duration as long as 5 years. On the other hand, real-estate and business loans are rarely offered for less than one year.
In a rather non-intuitive way, interest rate usually isn’t correlated with the duration : within a same loan class, longer-term loans usually don’t yield more than short-term ones. Indeed, the risk is the main factor that influences the interest rate.
An obvious consequence of investing in a long-term loan is that your money will be unavailable for longer.
At this point, you may be wondering how all these criteria fit together. As the saying goes, a picture is worth one thousand words, so here’s a graph showing recent loans from different platforms.
We can extract many useful data from this graph :
- The largest loans are real-estate and business loans
- These two kinds of loans also usually yield more than personal loans
- Unsecured loans don’t always yield the highest returns; it actually depends on how speculative the project is
- There’s little correlation between the loan duration and the interest rate; it’s possible to find short-term loans with high returns as well as very long-term loans with much lower returns
Wrapping it up
I realize that this rather long list of criteria may seem intimidating. However, it all boils down to the same question : how much risk are you willing to take in order to get better returns ? If you’re a beginner crowd-lending investor, it won’t hurt to focus on short-duration loans offering a buyback guarantee. Once you gain more confidence, you can always diversify your portfolio with riskier loans !
Our next article will briefly focus on the features offered by crowd-lending and P2P lending platforms.