The most successful investors tend to be the most informed, and this is particularly true when it comes to peer-to-peer lending, as it is a relatively new investment product with a wide variety of choices available between products and providers.
Filip Karadaghi (pictured), co-founder and chief executive of P2P lending platform LandlordInvest, has a background in finance and his long-standing experience in the P2P industry has highlighted the importance of investor research and due diligence.
He shares the six essential questions that every P2P investor should be asking before making any investments. This is mainly related to platforms that offer property-backed loans but can in some instances be applied to platforms that offer loans to businesses or individuals as well.
Do the platform’s offered rates correspond to the risk?
Karadaghi believe that the rates being offered by the platform should correspond to the risk. This is something that LandlordInvest has been doing since day one, says Karadaghi.
A first charge loan should have a much lower risk than a second charge loan and the offered rate should therefore also reflect the difference in risk between these two products.
Another consideration is that it is important to look at the spread that the platform charges (i.e. the difference between what the borrower pays for their loan and how much investors receive from it) and ensure that it is consistent across product ranges and risk.
Indeed, it is a regulatory requirement for platforms to set out the cost of credit for a borrower and a loan, and investors should carefully check it and ensure that it is fair, reasonable and reflects the risk of the loan.
Read more: The P2P Investing Report – out now!
What is the platform’s default rate?
Some property platforms have historically maintained default rates of between 30 to 40 per cent, which is very high for property-backed lending. The industry standard is around two per cent, while LandlordInvest has averaged around three per cent, by comparison. All platforms are now required to disclose their default rates in an annual Outcomes Statement.
High default rates suggest that the platform may be lending to less creditworthy borrowers. If that is the case, rates offered to investors should reflect the increased risk, as it is likely that borrowers pay a higher rate than market rate as well.
What are the incentives to invest?
Be careful when choosing to invest in a platform due to generous cashback or referral schemes. These incentives play a significant role in changing conditions and behaviours. To quote Benjamin Franklin: “If you would persuade, appeal to interest and not reason”. Economists would refer to this as a moral hazard.
What is the LTV and valuations?
Some platforms engage in a practice where the loan-to-value (LTV) is close to, or over 100 per cent. No mainstream or respected alternative platform or lender would engage in such practice for obvious reasons and investors should be careful of platforms offering such high leverage.
Platforms should also disclose a detailed valuation report along with the platform’s valuation instructions so that investors can see on what basis the valuation was carried out. Valuations should always be carried out by top tier valuers (to the extent that it is possible) to ensure as realistic valuations as possible.
Who is on the platform’s management team?
An experienced management team is vital for the success of a lending platform. However, experience alone is no guarantee of success, and taking the time to review shareholder composition is also key.
“Look at both the management team and the shareholders,” says Karadaghi. “Shareholders are important as they can put pressure on the management team to pursue short-term goals over long-term goals which may lead to the platform engaging in reckless lending practices.”
Can you ask questions?
The capacity to ask questions is a key part of any due diligence process. Platforms should offer investors the possibility to ask questions directly when assessing a loan and also after the loan completes. Keeping the Q&A section public also ensures that all other investors in that loan can benefit from the information disclosed in the Q&A section.
Read more: What IFAs want from P2P platforms