- January 27, 2020
- Posted by: AH Sagar
- Category: Investment Strategies
If you have ever tried to ask for a loan at the bank, you will know that the process is tedious and that in the end the answer is probably a “no”, it makes our time a waste. If we talk about being the party that grants the loans, sometimes we would like to not be limited by rules to grant them when it suits us.
What is crowdlending and why does it exist?
Crowdlending consists in the collective financing of loans to individuals or companies.
In other words, a number of investors put in common capital to jointly finance loans to other people or entities.
Thus, collective financing allows each investor to invest small amounts of money in numerous loans, so that it can diversify among a large number of loans.
The return that investors obtain for their investment comes in the form of interest to be paid by the borrower of the loan in return for the borrowed capital.
For this investment to be possible there must be a platform that acts as an intermediary between investors and borrowers who request financing. Therefore, it is a 100% online investment as far as the investor is concerned.
In some cases, the loans are granted directly by the platform (or its subsidiaries), while in other cases, the loans are granted by loan originators who use the platform to be able to leverage and be able to lend to a greater number of people thanks to the capital that they get from investors themselves.
It is important to highlight that in the article I am not going to talk about other forms of collective investment such as equity crowdfunding (collective start-up financing) or real estate crowdfunding (collective real estate financing).
The reason is that, although they have certain similarities with crowdlending, they also have important differences in terms of risk management and taxation.
Clarified this point, we will see below that there are several reasons why crowdlending exists. The main one is that in some cases, borrowers do not have access to financing by traditional banks.
This may occur for one or more of the following reasons …
- In certain countries there is no banking system as developed as we know it in Western Europe, so borrowers must resort to other types of credit institutions.
- The risk profile of the loan applicant is too high for a traditional bank to grant a loan. As we will see later, this reason is mainly one of the two main risks of crowdlending.
- The requested amounts are very small.
- The time horizon of the loan is often too short for a bank.
- The loan is requested for a concept for which a traditional bank does not grant loans.
- If the borrower is urgently in need of financing, he probably cannot wait for a traditional bank to carry out its usual internal verification and approval process.
In short, crowdlending exists because there is a gap that had to be filled. It is a structure that satisfies all the parties involved: on the one hand the borrower obtains the financing that he requires and that in other ways he might not be able to obtain and, on the other hand, the lenders obtain an interesting return on his investment.
What return can be expected?
Crowdlending is one of the most profitable investments that exist at the moment and that, however, require less time and knowledge and can also be done online.
In crowdlending it is common to obtain a return of between 9% and 14% per year, which is much higher than many other more traditional investment strategies.
The exact return that can be expected when investing in crowdlending depends on a number of factors such as …
- Risk of default: The worse the credit rating of the borrower, the greater the return offered since the risk of default is greater.
- Investment horizon: In some platforms, the longer the investment term, the greater the interest received. There are platforms that allow you to invest in very short-term loans (of only 30 days), while in others you can find several-year loans (usually loans for the purchase of vehicles).
- The platform itself: Within Europe, the platforms found in the Baltic Countries (in particular Estonia and Latvia) usually offer much higher profitability than can be obtained on platforms in other countries such as Spanish platforms.
- Country in which the borrower is located: In countries with less developed banking systems (and / or with higher inflation) it is common to obtain a higher return.
- Type of loans: If the loan is granted for a purpose that has a real guarantee (such as a loan to renovate a home), the interest rate will be better since in case of default the guarantee on the good can be executed.
- Whether or not the platform offers a buyback guarantee in case of delay or default. Since this implies an additional cost and risk for the platform, it is logical that the platforms offering this guarantee offer slightly lower returns.
Each investor must modulate these elements to invest in those platforms and loans that best adapt to their profile in terms of investment horizon, risk to be assumed, expected return, etc.
Every investment carries risk, and crowdlending is no exception.
In fact, many investors (especially the most inexperienced) begin to invest in crowdlending blinded by the high profitability that can be obtained, but without being aware of the risks associated with this investment.
Although there are some more, the two main risks of crowdlending are the following …
Risk of default by the borrower
As I have explained previously, one of the main risks of crowdlending is that the person or company to whom we have lent money is unable to meet the payment of capital and accrued interest.
If the person is declared insolvent and the loan was not associated with any guarantee, it will be unlikely that we will recover the money invested.
As we will see below, this problem can be minimized by investing the minimum possible amount per loan and, very importantly, by investing only in loans that entail a repurchase guarantee (although it is not an absolute guarantee, as we will see just below).
Risk of the platform disappearing
This can occur essentially for two reasons …
- The first is that the platform is a scam (for example a pyramid scam) or that it carries out fraudulent operations. That is why it is so important to do your homework and inform you properly about the platform that interests you before starting to invest.
- The second is that it is a legitimate platform, but that the economic situation is forced to face a large number of repurchase guarantees and that you have to close for that. The repayment of loans (especially those for bill payments) is closely linked to the state of a country’s economy.
In times of economic growth, the borrower will have sufficient funds to meet his obligations and return the borrowed capital and interest.
On the other hand, if a recession occurs and, for example, you lose your job, you are very likely to stop paying these loans because you need the little money you have to pay for other essential items such as food and lodging.
If the platform has promised to offer you a repurchase guarantee in case of default, then you as an investor will receive your money even though the borrower has not been able to pay his debt.
The platform will be in charge of trying to recover the money. Platforms usually have enough cash to deal with sporadic buy-back guarantees, so in normal time it is not a problem.
The problem comes when a significant number of borrowers stop paying their loans, because then the platform is suffocated by all the repurchase guarantees that it has to satisfy.
If the platform does not have a solid treasury, unfortunately it will have to close due to the mere fact that it does not have enough money to face all the buyback guarantees it has for the platform’s investors.
With this my purpose is not to scare you and scare you about crowdlending. But I think it is very important that you understand that crowdlending is not a risk-free investment, the main reason that justifies that profitability is so high.
What platforms to invest in?
There are currently dozens of platforms on which you can invest. But as I mentioned, not all of them are reliable, so you have to study well on which platforms you invest.
If you want to know which I have been investing in for years and with which I am very satisfied, take a look at my “Smart Investor” portfolio, which I do a monthly public follow-up: Smart Investor Portfolio.
You can see how much the portfolio earns month by month, you can compare the profitability of the different platforms that I have in the portfolio and, above all, how is each platform doing with respect to the expected return on each of them.
Investing in crowdlending itself is very simple and anyone can do it.
However, it is very important to invest with a clear strategy in mind to minimize the risks of the investment and the time it takes us to maximize the expected return.
Some strategies to invest in crowdlending with head are the following …
- Research any platform thoroughly before investing in it.
- Diversify between different platforms, different loans, different originators and different countries.
- Invest the smallest amount allowed by the platform on loan.
- Activate the auto-investment tool so that the platform itself invests for you as soon as there are loans that meet the criteria that you have previously indicated. This way you will save hours and hours of loan selection manually as it will be done automatically.
- Invest Always in loans that carry a buyback guarantee in case of delay and default.
- Do not invest more than 5-10% of your patrimony in crowdlending.
There are many other elements to consider to improve your investment in crowdlending, but if you apply these six strategic tips you will have done enough and you can rest easy.
Crowdlending is a novel and very popular alternative investment in recent times. You can get a very high return if you know how to minimize investment risks, if you invest in the best platforms and it is based on a clear investment strategy.