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How Much Bad Debt Is Acceptable?
Bad debt: that's when a loan goes past just being “late” into what's called “default” or “non-performing”, and even beyond – when not all that debt can be recovered and it is “written off”, never to be seen by lenders again.
Bad debts are a fact of life in P2P lending. All of us will suffer them sometimes and they can sometimes eat into our returns.
Usually, the interest we earn easily covers those losses. Or the borrower's property could be sold to recover all the money. Or the P2P lending site has a reserve fund set aside to cover bad debts – or other protections.
But how much bad debt is too much – a warning sign that a P2P lending site might not have a grip on what it's doing or how good its borrowers really are?
Prime, low-risk personal loans
Looking back at what 4thWay's experts generally talk about is an acceptable level, they've said that, generally, bad debts on persona loans should not be vastly above 1% to 1.5% per year. There will be worse years, so this is an average.
Also, extra wiggle room is allowed if there is a particularly large reserve fund. The P2P lending site might deliberately accept some borrowers a bit higher up the risk scale if it is covering the extra risk.
If you bad debts are higher than this, or if there is no reserve fund at all, you might want to make sure interest rates are higher than other prime personal loans P2P sites to compensate you for any extra risks.
I just looked at the two most prominent P2P sites that focus exclusively on personal loans. Currently, Zopa, the oldest P2P lending site in the world, still has under 1% annual bad debt on loans that were issued in 2014 and 2015. Lending Works* has around half a percent!** I've excluded 2016 and the start of 2017 because those loans are still very fresh, although they look strong too.
Prime, rental property loans
Rental property should almost always have a very low bad-debt rate in very low single figures, even in bad years. This should be lower than personal loans.
Property P2P lending sites are still small enough right now, it seems, that they can be super selective of quality borrowers, and so the bad-debt rates on rental properties have been zero.
If you spot any with bad debts (I haven't) perhaps they are not so good at selecting the cream of borrowers.
Prime business loans
It looks like, for prime business borrowers, in recent years we have seen the annual bad-debt rate is below 2% per year.
Very small business loans P2P lending sites – so just a few million in completed loans – sometimes have bumpy starts as they test their new processes on business borrowers – a form of borrower that is harder to judge than individual borrowers.
This makes those smaller P2P sites harder for us to judge too, but certainly if there's a huge bump in bad debts you need to be even more cautious.
You can compare bad-debt statistics in our detailed comparison pages, comparing up to five platforms at once. To do this, go to the main comparison table page, check the checkboxes on the right-hand side in the comparison table and then click on the “Get more details” button at the top.
If a P2P site is not listed on 4thWay (that's not our fault! they just haven't shared their info with us), they might have their own statistics pages on their website. If they don't share their bad debt figures, or the figures are not totally clear, our experts say “avoid”.
Finally, low 4thWay Risk Scores show that bad debts are almost certainly low and easily contained by defences such as property that can be sold if the borrower can't pay or reserve funds. Again, risk scores are shown in our comparison tables.
*Commission, fees and impartial research: our service is free to you. 4thWay shows dozens of P2P lending accounts in our accurate comparison tables and we add new ones as they make it through our listing process. We receive compensation from Lending Works and other P2P lending companies not mentioned above either when you click through from our website and open accounts with them, or to cover the costs of conducting our calculated stress tests and ratings assessments. We vigorously ensure that this doesn't affect our editorial independence. Read How we earn money fairly with your help.
**Note that Zopa and Lending Works usually present their bad-debt figures differently. They are not talking about annual bad debt like me. They look at all the loans that were lent in, say, 2015 and then they say how much of that has gone bad in 2015, 2016 and 2017 altogether. That's why their figures look higher than mine.