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Secured Lending Vs Provision Fund. Which is Better?
P2P lending companies use many different ways to lower the risks of lending your money. I'm going to compare two of those ways today: secured lending and bad-debt provision funds.
At 4thWay, we take great pains to avoid technical language or at least to explain it clearly in our articles, guides and blogs. However, there's a lot of somewhat technical stuff you need to understand before you can grasp this blog. Those things include:
- Secured lending.
- Bad-debt provision fund.
- Loan-to-value (LTV).
- First charge (or “taken into trust”, which is virtually the same as a first charge).
Sorry to hit you with all those, but I can't think of a good way round it. If you want to understand which is better, secured lending or a bad-debt provision fund, you need to know those terms.
So: you could bone up using our glossary of Peer-to-Peer Lending Definitions.
Or, if that's too much for you, the 4thWay® Risk Ratings take all of these things into account, and more. so you could use them as your guide. You'll see these ratings when you compare P2P lending companies.
We also offer more information in our comparison tables.
Secured lending vs provision funds
I'm done with definitions. Let's get started!
If you're going for safety first, the very first thing you want to do is make sure that the P2P lending company focuses very hard on at least one of these two things:
- Only allowing very high quality borrowers to borrow from you.
- Ensuring that all the loans are secured on property at low LTVs.
If the loan-to-values are high, it doesn't matter that it's a secured loan; you are probably not looking at a low-risk P2P lending opportunity.
For unsecured loans, the borrowers must mostly be prime or even “super-prime”. Otherwise this is probably not low-risk, even if there's a bad-debt provision fund.
Two great P2P lending companies
Let's assume there are two P2P lending companies.
One has very high quality borrowers and a large bad-debt provision fund.
The other is a secured loans P2P lending company that has low LTVs.
Comparing the two isn't easy with the naked eye. Even when we calculate 4thWay® Risk Ratings for such P2P lending companies, we find that they have almost identical scores.
But that's not just because of the security. And it's not just because of the quality borrowers and the provision fund. It's because companies that are disciplined and focus hard on the important things also tend to get other things right too. They have low instances of fraud. They offer additional ways to reduce risk, such as insurance to cover losses.
So I can't say, in a word, which is better: quality secured lending or a provision fund with prime borrowers. But I can say that both vastly reduce your risks.
What is “quality security”?
You're still in the dark as to what “quality security” is and what qualifies as a “prime” borrower? And what is a “very large” bad-debt provision fund?
I'll give you some rough proportions of what should work out well in a crisis:
- If LTVs average around 55%, that is extremely good.
- If average LTVs are around 65% with a reasonable sized bad-debt provision fund, that is extremely good.
- If a bad-debt provision fund is around 1.5% of outstanding bad debts, that is reasonable sized.
- If a bad-debt provision fund is around 3.5% of outstanding bad debts, that is very large.
- If just 10-15% of loan applications are accepted, these are mostly prime or even “super-prime” borrowers – provided the P2P lending company has reasonable skill at selecting them.
That's not the be all and end all
Clearly, you won't just consider those risk factors. You'll look at others. But I hope this short blog helps you to grasp secured lending and provision funds a bit better.
In addition, all this analysis might mean nothing if you don't spread your money across lots of loans. After all, one loan can go terribly wrong, whether it's a 55% LTV secured loan or not.
The 4thWay® Risk Ratings were devised by experienced investors and a debt specialist from one of the major accountancy firms. The score is calculated using objective criteria that can be measured and improved over time, although no risk-scoring system is perfect. Read more about the 4thWay® Risk Ratings.