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P2P Lending: How To Deal With Rising Interest Rates
First it was inflation, now it's rising rates. That might sound like fun when you're a lender, but it comes with its own issues for lenders to ponder on and deal with.
This article gives you practical lending tips on handling rising rates.
If you have time to spare and want to read a purely educational piece to learn why it is that the Bank of England's base rate impacts rates charged by banks, P2P lending companies and other non-bank lenders, read How The Bank of England Rate Impacts Different Kinds Of Lending.
When you're locked into lending at lower rates
P2P lending is almost invariably fixed-rate lending. Your existing borrowers aren't going to start paying you more just because rates today are going up. Your cash is tied to that and it's not partaking in any increases.
However, this is simple. Just as the banks do when they offer fixed deals, you simply re-lend what comes into you at the higher rates. The banks also have to wait for existing borrowers to repay and it doesn't stop them making a lot of money doing money lending. (If you overlook the crazy subprime junk that contributed to the 2008 Great Recession anyway.)
Repayments for almost all kinds of lending in P2P come in faster than you think. Five-year business and personal loans that have regular repayments typically see over half your money repaid within 18 months, partly due to early payments. Most property lending is repaid in full within 18 months. So you'll be able to catch up with rising rates faster than you think.
If you look at your outstanding lending and you see a lot of it is for longer than 18 months with the actual loan to be paid in full at the end, consider getting more of it into faster repaying loans, as and when it's repaid to you by borrowers.
If you think you're going to want to sell loans
Really, as we always say, if you think you might need to sell most of your loans to get the cash back in the next few years, you probably should be lending less money right now.
In practice, we know that many lenders don't heed this advice and hope for the best that, when the time comes, they'll be able to sell their loans before their borrowers repay them naturally.
It's totally your decision to take that chance. But I just want to warn you that many people are angry when they're unable to sell exactly when they need or want to. And you'll only have yourself to blame if that happens, because you've been warned and it's a completely avoidable situation for most people.
If you're one of those determined to keep lending while needing that cash back is getting more imminent:
Those buying loans from you will expect you to sell at a discount, to make up for the fact they're taking over loans that are no longer paying today's interest rates.
Some P2P lending companies don't allow you to sell at a discount, so you might just find it harder to sell your loans at all.
I suggest that you stop re-lending your money and have it gradually repaid to you by borrowers as soon as you think you're likely to need a lot of it within a few years, or when you need to stock up your emergency savings.
When your borrower rates don't rise much
Some P2P lending providers might not ever raise rates much, if at all. As I explained in the accompanying educational piece, some types of lending are not directly linked to the general rate rises and other one-off, unique factors can impact rates too.
Yet you don't have to give up completely on quality lending accounts that you already have, just because their rates aren't rising with the base rate. A balanced portfolio of lending accounts can easily pay around 6% per year after bad debts. This provides a very solid basis for your lending that is considerably more attractive than savings accounts and cash ISAs.
Not that lending is equivalent to savings, of course, because lending is an investment with different risks and rewards to saving.
But, in the time that the base rate rose 1.15 percentage points, easy-access accounts went up just 0.3 percentage points to average a mere 0.4%. Cash ISAs are just fractionally better. This is actually par for the course when it comes to variable-rate savings. Savers should not expect to ever catch up with the base rate.
Fixed-rate, two-year savings have only just hit an average of 2.1%. The rises here were actually a tick faster than the rising base rate, but only because banks want to lock savers into these low rates, while the base rate skyrockets even further in the coming months.
When savings outcompete lending
Savers who shop around can nudge up their savings rates to something more substantial. In times of moving interest rates, this can create temporary anomalies to watch out for.
4thWay's specialists have called Loanpad* the safest investment of any kind in the UK and “an investment that will keep your money safe through everything short of nuclear war”. Yet, being so low risk, it also comes with low rates compared to other P2P lending. The lower the rates, the more susceptible those rates are to being outcompeted by savings.
Loanpad's highest-rated account has ticked up slightly and maintained a distance from savings, being now 4.2%.
But its lower-rated account still pays 3.0%, and so it's now beaten by the highest-paying, two-year, fixed-rate savings accounts. Union Bank of India (UK) Ltd pays 3.3%. And well-known brand Tesco Bank is paying 3.01%.
Yes, you're 100% tied in for the full two years when using those savings accounts. And yes, that Loanpad account comes with easier access than Loanpad's higher-paying account (provided you're able to sell early) and its rates could still shift upwards in the next few months.
But its surely reached the point where you must wonder why you're even taking the extremely tiny risk of lending through that particular Loanpad account.
Take the long-term view to shape your strategy
Over the coming months and quite possibly years, you might find some of your lending rates are going up, but the pace is generally dragging behind the base rate. What you mostly need now is patience.
When rates stabilise, and start falling again, you'll make up any lost ground, because your borrowers will be tied into paying you higher rates as newer borrowers pay less. So you benefit from the reverse effect.
Contain your greed
Don't chase the interest rates rising fastest just because you feel you're missing out. The whole point of money lending – at least most money lending – is that it's usually highly predictable. Spread your money across lots of types of lending from different sources and you have a very high chance of having more money in a few years time, regardless of what happens to the economy.
Sometimes, you make more money than others, and sometimes you make less. But shifting to ever riskier lending is not the way to go.
They say that you shouldn't invest in something just because it has tax advantages. You have to focus on the underlying investment. Similarly, if you do look to put money in other accounts because rates have risen, you still have to be confident – above all else – that they're excellent accounts.
A few more tips
You might want to shift money into accounts where the lending rate is directly linked to the borrower rate, in a transparent way. For example, where the P2P lending company tells you that you'll earn what the borrower pays in interest, minus a 1% fee. Thus, any increase the borrower pays goes straight to you and not to the P2P lending company.
Don't be afraid of rising rates. All the historical bank data 4thWay's specialists have seen shows that there's not a strong correlation between rates going up and worse profits after deducting bad debts. In the times where they have correlated, those higher rates have invariably offset enough bad debts that lenders in general continued to make at least some money.
With rate movements often comes other big, negative news affecting different parts of the economy and therefore different types of borrowers. You need to make sure you keep a balance. While you're making any lending adjustments you feel are necessary to adapt to rising rates, please still keep up the diversity of different types loans, and different quality of and traits in your borrowers.
Sources: Liberum; Bank of England; Moneyfacts..
Independent opinion: 4thWay will help you to identify your options and narrow down your choices. We suggest what you could do, but we won't tell you what to do or where to lend; the decision is yours. We are responsible for the accuracy and quality of the information we provide, but not for any decision you make based on it. The material is for general information and education purposes only.
We are not financial, legal or tax advisors, which means that we don't offer advice or recommendations based on your circumstances and goals.
The opinions expressed are those of the author(s) and not held by 4thWay. 4thWay is not regulated by ESMA or the FCA. All the specialists and researchers who conduct research and write articles for 4thWay are subject to 4thWay's Editorial Code of Practice. For more, please see 4thWay's terms and conditions.
*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 Loanpad 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.