How Do Platforms Evaluate Peer to Peer Loans?
In today’s post, we’ll discuss how peer to peer lending platforms (P2P) evaluate peer to peer loans. There are a range of P2P investment opportunities available on the market, but understanding which ones are safer than others depends on a number of factors; critically, how the loan originator assesses the quality of the loan.
Borrower risk overview
The greatest risk posed to P2P investors is borrower default resulting in loss of funds. If the borrower is unable to repay their loan due to poor due diligence on the platform’s part or economic stress, perhaps due to unemployment, then investors may suffer losses.
Many P2P investments are secured with assets, such as property. If the asset hasn’t been accurately valued or the property market significantly dips, then it may drop in value and compromise the buffer of security protecting investors’ capital. For example, if the property value (i.e, security) is 125% the value of the loan and the property drops 50% in value, it is only worth 75% of the loan value, which means the property wouldn't fully cover the debt owed should it need to be sold to recover the debt.
How a platform determines the creditworthiness of its borrowers and secures loans should be primary considerations when doing your research.
Here are some key questions you may wish to ask when doing your platform due diligence:
When researching consumer-lending platforms: What risk grade are the borrowers? What data is collected? Which data sources are utilised?
When researching business-lending platforms: What security is taken? Director personal guarantees or an all-asset charge? Does the credit team meet with the business and, if so, how often? How far back in time does the platform go in terms of reviewing business accounts?
When researching property-lending platforms: What type of property loan is being made? Development, residential, buy-to-let? Is the loan-to-value ratio of sufficient coverage? How experienced are the borrowers, particularly if property development?
If this sort of information is not readily available on the platform’s website, you may wish to get in touch directly to understand how they evaluate peer to peer loans, or, question the quality of the platform.
How platforms evaluate peer to peer loans
The way borrowers are assessed differs depending on the type of borrower, size of loan, purpose of loan and so on. Generally, platforms adopt broadly similar borrower assessment processes, but this doesn't mean they always approve the highest quality loans. The quality of a platform's loan appraisal can be measured by reviewing their default rates. If a platform has a high default rate, this may infer that their process of evaluating loans is not as effective as it should be.
The table below gives an overview of the assessment criteria and processes for a select few P2P platforms.
When researching platforms, you can typically find this information on the platform website. As mentioned earlier, generally, platforms will adopt similar assessment criteria and processes to the above examples; creditworthiness and affordability are primary factors platforms will consider when appraising a loan. External data sources and experienced internal teams combine to ensure the evaluation of loans is as accurate as possible.
Alongside how platforms assess borrowers, you should understand how recoveries are managed. Most major platforms will publish their ‘default’ and ‘bad debt’ rates – a ‘default’ is usually defined as a borrower being unable to repay their loan, with legal action potentially required to recover the debt. ‘Bad debt’ is when the borrower is unable to repay their loan and the debt is irrecoverable, therefore losses are experienced. Some platforms may offer different definitions, so ensure and research this carefully.