Investor’s profile : deciding which loans to invest in

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 !

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 offer a lower interest rate.

Buyback guarantee is only available for individual loans; it usually doesn’t cover real-estate crow-lending and business loans. The term “unsecured loan” is often used in this case, as opposed to “secured loan” for those covered by the buyback guarantee.

This shield icon will denote loans with buyback.

This warning icon will signal unsecured loans.

Investment duration

With the buyback option, this is probably one of the most important factors when determining your investor’s profile. Some peer-to-peer platforms specialize in short-term loans, while other offer loans for a duration as long as 5 years. Interest rate is usually correlated with the duration : the longer the duration, the higher the interest rate – although for long-term loans, it actually depends on the platform -.

Another obvious consequence of a longer loan is that your money will be unavailable for longer. While it may be possible to resell the loan before its maturity, I strongly advise against investing money you may need !

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

Should you choose to invest in individual loans without a buyback guarantee, you may have to dig a bit further. Individual loans may be sub-divided into payday loans, car loans, home improvement loans… The loan kind will mostly influence its amount, which will condition its duration, which will in turn affect the interest rate. Also, 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.

Here are the icons we’ll use to depict the different loans kinds :

This icon will signal individual loans

The factory icon will be applied to business loans

Real-estate loans will be signaled by the house icon

Sample loans

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 informations from this graph :

  • The best interest rate for secured loans (i.e., with buyback) is 15%
  • The largest loans are real-estate and business loans
  • Unsecured loans don’t always yield the highest returns; it really 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

Additional criteria for unsecured individual loans

When investing in peer-to-peer loans not covered by a buyback guarantee, two loans parameters influence the interest rates. Making your mind about them is the last step toward deciding your investor’s profile.

Borrower's credit rating

So, you choose to invest in unsecured loans. Still, it may not be such a risky path; you actually can control how much risk you’re willing to take. Do you want as few defaults as possible, resulting in a lower interest rate ? Or are you willing to take more risk, with borrowers who received a less appealing rating, but ready to pay more interest ? That’s obviously a hard decision to make. Looking at the platform statistics should help you in your decision, as the rating themselves are rather subjective; the default rate itself for each rating is much more meaningful.

Borrower’s country

This is not a criteria by itself, but it influences both the recovery rate and the offered interest rate. Usually the platforms have high recovery rates in their home country, but may not be as efficient abroad. Also, the interest rate that borrowers are willing to pay highly depends on the local banking offering.

 

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.

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