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Trading Loan Parts At A Profit Or Loss
A “secondary market” is what makes this all possible.
What is a secondary market?
A secondary market allows you to buy and sell existing loan parts to or from other lenders.
You might do this for bigger profits, to exit early or for other reasons.
The only realistic way to leave P2P lending loans early is usually through a secondary market, although some providers, such as Assetz Capital, sometimes use cash they've set aside to help you leave faster.
You can see a list of all the P2P lending websites with secondary markets in Where Can You Buy Or Sell Existing Loans?
Fees for buying and selling loan parts
Sometimes it costs you a fee to sell loan parts. (On a tiny minority of platforms, you can be charged for buying loan parts instead – or as well.)
These selling fees – when charged – are typically between 0.25% and 1%, but they can get higher. These are also sometimes called your “exit fees” when selling.
Consider how often you might want to trade, so that you can estimate the impact of repeated selling fees. Selling fees of 1% on rapid trades is going to really take a bite out of your profits.
But you also need to consider the overall costs of the P2P lending platform – because it might have high selling fees but low costs overall. (To figure out the overall costs, you'll need to understand that There's No Such Thing As “No Lender Fee”.)
The fun way or the easy way?
In the next few sections, I'll cover how most of the P2P lending platforms' secondary markets work. These are a bit more complicated, but also more fun and offer more potential for profit.
In the last section I'll cover how the easy, “boring” ones work, although they have the advantage of being very simple and less about profiteering, in case that's not your cup of tea.
Selling at a profit or for a loss
Most P2P lending websites allow you to choose the specific loans you have that you want to sell.
You're also often able to set the price to sell at. By “price”, I mean that you sell the loans for more or less than you originally lent.
Here's an example. Let's say that you want to sell £1,000 of your outstanding loans. You could sell them for £1,000 to get your money back. Or you could sell for a discount of, say, 3%, which is £970. Or you could try to sell it for a profit at £1,030.
Some P2P lending websites cap the size of the discount or premium you're allowed to sell at.
How the premium and discount affects you
Let's say your £1,000 of loans were going to earn you £100 in interest over the next 12 months. Someone buying for £970 will now earn that £100, plus the borrower will repay £1,000. Since the new loan holder only paid £970, he or she will make an additional £30.
You, on the other hand, might have already earned £100 in interest on those loans. You're getting £30 less back, so overall you've made £70.
Reasons to sell at a discount
- To sell your loan parts more quickly.
- Other lenders will only buy at a discount because they're worried about the safety of your particular loans or of lending right now generally.
- Because you'll get a much better deal, despite the discount, by taking your money back to lend elsewhere.
When buying at a discount
It might seem like a no-brainer to buy at a discount, but there could be a good reason for the price being low: maybe the borrower has missed a payment or something. Check it out.
Even if you buy at par (or a premium), that doesn't mean nothing's wrong. So always check it out.
Reasons not to buy at a premium
Firstly, two reasons not to buy at a premium.
- Many P2P lending sites allow borrowers to repay early. If you buy at a premium and the loan is repaid shortly afterwards, you won't have earned enough interest to cover the additional price you paid.
- At least one platform that is now defunct, called FundingSecure, could have given you a tax loss on some loan sales, because when you bought loan parts from other lenders you bought the loan plus all the interest that lender has received. In this special case, particularly if the borrower then repays early, you might have had to pay tax on that interest, which could have given you an immediate, although probably small, loss. Such losses are likely to be rare, but you can read a bigger description of how it happens here. This doesn't apply to buying loans inside IFISAs, because you're not taxed.
Those two bullet points give you even more incentive to spread your money across lots of loans, so that you earn enough interest from other loans to make up for any potential losses from that.
Reasons to buy at a premium
- To get your money lent out more quickly. There's often a lot more choice on the secondary market than in new loans. Plus, new loan auctions can take days or weeks to conclude on many P2P lending websites, whereas you can buy existing loan parts right away.
- To spread the risks more quickly and widely, and over loans that started at different periods of time. Older loans might sometimes be safer.
- Because you know more about the borrowers now than the original lender did (since the borrower has established a payment history or completed critical groundworks successfully on a development) and a higher price is now fair for the lower apparent risks.
- Because the adjusted interest rate is the same or higher than you can currently get on new loans.
When selling at a premium
That last two bullets in that last list also help you decide whether you might sell at a premium: if you think that the risks are lower now than they used to be or because you know the buyer will still get a better deal than buying new loans.
If you sell at a premium you might have to pay capital gains taxes. More on taxes in our tax guide: How Is Peer-to-Peer Lending Taxed?
Buying and selling bad loans
“Impaired loans” can include those that are late or, worse, those that are classed as bad debts or “in default”. But there's no strict definition of any of these terms.
Most P2P lending websites won't allow lenders to sell loans that are impaired. This is a shame, since a truly open secondary market (like the London Stock Exchange, for example) – would allow people to sell damaged loans at a deep discount to people willing to take big risks. At least you could then be sure of getting some of your money back too.
Warning signs to watch for
Sometimes a loan has had some late payments, but it's now up-to-date again. This means it's no longer impaired and most P2P lending providers will now allow the loan to be bought and sold again.
While it's now currently paid up, the risk of that loan going bad is probably higher than on a loan that has never been late. So this is something worth watching for – provided you can find that piece of information. In this case, you might decide either not to buy or only to buy at a good discount.
In addition, in the event that a P2P lending website grades its borrowers, and it lowers the grade of a borrower, this is also a warning sign to watch out for of a higher risk of the loan going bad.
Perhaps you could avoid buying such loans and try to sell them if you've got them.
The easy-to-use secondary markets
Some P2P lending websites don't allow you to choose individual loans yourself. Your money is usually spread across many borrowers easily and automatically. With these, you usually don't even know who your borrowers are.
The secondary markets here are much more simple. You can't set premiums and discounts. You just decide how much you want to sell. The P2P lending website then allocates your loans to the next available lender.
Most of these – if not all – will prioritise reselling your parts over getting new borrowers.
You might still have to pay exit fees. And you'll usually have to accept back slightly less if the new lender is missing out on higher interest rates from new loans.
For example, if the loan parts you're selling are earning 6% and the interest rate on new loans is currently 7%, you'll have to sell your loans for a fraction less in order to compensate the new lender.
Finally, you might also receive less back because you'll now lend for a shorter term than you signed up for. For example, say you can choose to lend today for 6% for five years or 5% for three years. If you lend for less than five years, you might receive a bit less back to adjust the total you've received to the equivalent of 5%.
While these secondary markets are easier – since you don't have to think about it – it does mean there's no potential for a big profit on a sale.
Worse, it could potentially mean it's harder to exit early during extreme times, such as panics and recessions. This is because you can't deliberately offer your loan parts at a discount to tempt people to buy when they've become more worried about lending.
Read more: Where Can You Buy Or Sell Existing Loans?
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