How secure are your P2P investments?

Security goes hand in hand with peer-to-peer lending, and with lending in general. Any responsible lender wants to ensure that they have the best possible chance of recouping their capital investment, and by taking a form of security on each loan, they at least ensure that they will have a sellable asset in the end, even if the borrower defaults on their repayments.

So how does this work in P2P lending?

P2P platforms essentially act as intermediaries between borrowers and investors. The investor adds money onto their platform of choice, and these funds are distributed across a range of different loans. It is the platform’s responsibility to assign a risk rating to each loan so that investors can choose only those loans which match their individual risk profile. For example, property lender Kuflink assigns ratings ranging from A1 to C1 on their loans, with A1 representing the lowest risk opportunities.

Read more: Why security matters for investors

Risk can be a tricky thing to assess, but P2P lenders are experts in it. They look at everything from the experience of the borrower; to the macro-economic issues that could impact the term time of the loan or the ability to recoup the capital and interest. This process can take weeks, if not months, to ensure that only those loans with the best chance of being repaid are admitted onto the platform.

But no investment is entirely risk free. And that’s where security comes in. Security provides a safety blanket for investors, as it means that there is an item, property or service of value that is attached to the loan in question, which can be sold off if need be.

Property security

Security is particularly common when it comes to P2P property lending. Just about every P2P property lending platform takes security in the form of the property that they are funding. On residential, commercial and buy-to-let (BTL) properties, a loan-to-value (LTV) is calculated before any offer is made to the borrower.

For instance, if a landlord requests funding to buy a new BTL property worth £300,000, the P2P platform may assign a 60 per cent LTV, offering £180,000 in financing. If the borrower defaults on their repayments, the platform could in theory sell the property in order to recoup the £180,000 investment. Most P2P platforms cap their LTV at 70 per cent, as this means that property prices would have to decline by at least 30 per cent before their capital is affected. This can offer peace of mind for retail investors who may panic at news of property price drops. It is worth noting that during the global financial crisis, property prices did not typically decline by more than 20 per cent.

Read more: P2P bosses predict rise in unsecured loan defaults

A first charge security is preferential for investors, as it means that they will be first in line to be refunded if the borrower defaults and the property is sold.  Second charge security means that you will be second in line to receive any money after the property has been sold. It is usually limited to bridging loans, which have a shorter term time and tend to attract more risk-aware investors.

Non-property security

On non-property loans, the issue of security can become a little more complicated. Some consumer and business lenders will still take property as collateral on any loans, while business lenders may also take security in the form of machinery, site leases, or the even intellectual property rights of the business.

Consumer lenders and pawnbroking lenders have much more leeway in terms of the security that they can request. P2P pawnbroking lenders can accept any item of value, ranging from jewellery or watches, to boats and fine art. Some lenders have even taken possession of luxury cars and wine collections in return for borrower funding.

Read more: How to address inflation with your P2P portfolio

If the security is a physical asset (such as a piece of artwork), it is the responsibility of the P2P platform to value the piece accurately, collect it, and store it appropriately. It is therefore vital that investors have faith in their platform’s operational ability before investing in loans backed by non-property assets.

How do you know what security is attached to your loan?

Any details surrounding loan security should be available on the platform’s website, and easily verified with a call to the platform. It is extremely rare for platforms to offer loans without any form of security attached, although where this does happen the loans will usually be categorised as ‘unsecured’. In exchange for the higher risk associated with unsecured loans, higher returns will usually be offered.

The variable nature of P2P loan security underscores the importance of doing proper due diligence before making any new investment whatsoever. P2P is considered to be a high-risk investment, according to the Financial Conduct Authority, and should therefore be approached with open eyes and a willingness to understand the ins and outs of each platform and their borrower terms. Read the fine print, and look out for key terms such as ‘LTV’ and ‘first charge’ to ensure that your investment is as secure as it can possibly be.