At P2P comparison and tips website 4thWay, we can see why lending through personal loans platforms such as Zopa is part of the staple diet for both individual lenders and professionals alike.
The attraction is the low-risk profile, reliable and predictable nature of personal loans. Here’s how we know it’s low risk compared to other forms of lending:
1. Interest rates are a useful sign
Comparing interest rates is usually a surprisingly accurate gauge of the relative risks between two different types of lending. And there is a stark contrast between what individuals and businesses can pay to borrow.
Over half of individual borrowers who are accepted for best buy loans will pay around 4% to 8% APR.
In contrast, for small businesses, the norm is to pay double digits of interest - sometimes high double digits. That’s even for business loans where the borrower has to provide a guarantor. Even secured business loans – which means it is relatively easy to repossess and sell the borrower’s assets - tend to start at around 8% or more, implying the risk is higher and relative to the returns on offer.
2. Easy to categorise
We might not like our personal credit scores - and they might not always be fair - but on balance we individuals are easier to predict than businesses.
Lenders like you and me - as well as P2P lending websites - can reasonably easily foresee whether personal loans customers are likely to repay and can afford the loan in the first place.
Business borrowers have multiple complicated facets to them. Many businesses are rare or even completely unique, making it hard to estimate the risks without specialist knowledge and insights.
In addition, people running businesses can frequently walk away from their debts simply by closing shop. Individual borrowers always have to face the music, in one way or another, which gives them a greater incentive to try harder.
Remember that businesses are often not just one person, but lots of people. Each one of them can collectively impact the business - for good or bad.
Therefore, platforms that underwrite business loans price in the risk in the interest rates, which is why business loan rates tend to be higher than the best personal loan rates in the market.
3. Easy to spread the risks
Personal loans are small and numerous, making it easy for lenders and P2P lending platforms to spread your risks across lots of borrowers.
The more you diversify and spread your money across many borrowers, the more confident you can be that any potential defaults will not reduce your gains to zero.
This means you don’t need high interest rates to try to compensate for a few big borrowers that suddenly can’t repay their debts.
An additional benefit is that P2P lending websites can learn more from their borrowers if there are more of them. Their professional risk modellers and data scientists can analyse all those loans to further improve borrower selection criteria and to better set suitable interest rates for them.
4. Low loss rates
Aside from some of the newer P2P lending websites that have completed far fewer loans, Zopa has the lowest loss rates of all.
Zopa has matched well over 100,000 loans since 2010, which is over 200 times more than most P2P lending websites. Yet Zopa has told 4thWay that its average annual loss rate for nearly half a decade has been an incredibly low 0.48%. (With loans since May 2013 covered by Zopa’s Safeguard - its reserve fund set aside to pay expected bad debts although it is not a guarantee or an insurance product.)
When looking at the loss rate, it can be useful to also consider the proportion of loan applications that are accepted.
Zopa accepts around 20% of applicants. Of the business lending websites that have a two-year or longer history and are transparent with 4thWay® about their acceptance rates, they all accept fewer applicants than Zopa, but still have higher expected and actual loss rates.
This indicates that, in order to reduce the risk to match Zopa’s loss rates, business P2P lending platforms might have to become more selective of who they allow to borrow - which makes it harder for them to offer enough loans to their lenders.
Despite the lower risks, Zopa’s five-year market still currently pays a projected annualised return of 5%, which is a fraction above the average in the 4thWay P2P Forecast Returns Index, which stands at 4.99% today.
You can follow Neil and 4thWay via Twitter - @trythe4thway
Disclaimer - Opinions are held by the author and not necessarily endorsed by Zopa