EstateGuru chief warns pressure for higher rates can boost defaults
EstateGuru chief executive Mihkel Stamm has warned that investor pressure for higher interest rates on loans could lead to higher defaults, as he underlines the advantages of risk-based pricing.
Many peer-to-peer lending platforms have been increasing their interest rates in order to compete better with savings accounts, after central banks globally hiked rates to temper soaring inflation.
“While there may be pressure to raise interest rates for loans, this can be detrimental to investors,” Stamm said in a blog post on the European P2P platform’s website. “Increased interest rates raise the burden on borrowers, affecting their affordability and cash flow and ability to repay the loan at maturity. Consequently, the probability of default rises as borrowers struggle to meet higher payment requirements.”
A higher cost of borrowing for a real estate project means that the borrower will have to allocate more funds towards interest payments, reducing the amount available for other project expenses, Stamm said, which can decrease the project’s profitability and overall financial viability.
The higher interest rate can also diminish the return on investment for the project, by eating into the potential profits generated.
Stamm also noted that higher interest rates can impact the property’s valuation, as it means higher yield which lowers the market value of the property.
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“Macroeconomics has an important role to play in setting interest rates,” Stamm said. “Given the current climate, you won’t see rates below 10 per cent for loans on the EstateGuru platform but rather than focusing solely on maximising interest rates, a shift towards risk-based pricing should be advocated.
“Risk-based pricing takes into account individual borrower profiles, assigning interest rates based on creditworthiness, equity in the transaction or other forms of security, borrower track record on the development or investment, the location of the property, the exit strategy of the borrower and other risk factors. This approach allows for more tailored loan terms and mitigates the likelihood of default.”
Stamm called for investors and the crowdfunding industry to more fully embrace risk-based pricing principles, highlighting that the new pan-EU crowdfunding rules mandate the use of credit ratings for borrowers on licensed platforms.
EstateGuru, which was approved for its pan-EU licence last month, will be integrating Moody’s credit rating models to enhance its risk assessment process and give investors more information.
“Understanding risk-based pricing and the consequences of interest rate increases on real estate loans is crucial for both investors and borrowers,” Stamm said. “By adopting risk-based pricing strategies, considering credit ratings, and evaluating the macroeconomic environment, the industry can strike a balance between investor returns and borrower affordability while minimising defaults.
“Ultimately, the success of a real estate investment relies on a proper underwritten assessment of various factors regarding the borrower, the related property acting as security for the loan, and the economic fundamentals of each country. Using interest rates as a standalone benchmark is not sufficient.”