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Why Should I Do Unsecured Business Lending?
You probably think a better question is “Why on Earth would I want to do unsecured business lending when I can do secured lending?
It's a good question. Secured business lending, after all, means that you are lending to a business that has property, equipment, machinery, cash or other assets that legally can be repossessed and sold on your behalf if the business is unable to repay. It is much easier to recover a higher proportion of any debt that goes bad when loans are well secured.
Unsecured business lending means that all these assets won't have been properly valued and you have no automatic entitlement to them as lenders.
However, here are five excellent reasons why you should consider unsecured business P2P lending:
1. Easier to forecast bad debts
Firstly, with a large number of unsecured business loans, you can more easily look back at history to see a record and get some kind of idea of what bad debts will occur.
Secured business lending, in contrast, tends to be fewer loans to measure bad debts on.
2. You know what your situation is sooner
With secured lending, typically quite a sizeable proportion of loans go bad.
Yes, you expect to recover most of those bad debts and yes you are normally still due to be paid interest for the delay.
But it can take years before the loans go bad, with no real warning signs in advance.
Worse, recovering bad debts on secured loans can take months or even years. You can be waiting ages to find out how those loans are going to do and whether it was a good idea in the first place.
With unsecured loans, you normally have the advantage that fewer loans go bad – if the P2P lending website is good at it's job and targeting the more typical prime borrower market.
You also have the odd advantage that you know where you stand earlier on, because more loans go bad earlier. Yes, this means you earn less interest before the loan goes bad, but you can factor in the losses sooner and do rough estimates of your recoveries, while moving on.
That's a slightly bizarre reason for unsecured business lending, I know. But the measurability of it is what makes it interesting.
It is not just you doing the measuring. The P2P lending site can more quickly measure how it is doing, learn from mistakes, and set better interest rates in future to cover risks, as well as more quickly weed out weaknesses in its borrower approval process.
3. Good for spreading your risks
There are two ways in which unsecured business loans are good for spreading risks.
Firstly, they tend to be smaller and more numerous than secured business loans.
You can't easily get into the situation that a few large P2P lending sites have found themselves in, whereby a handful of very large, multi-million pound loans caused a fair bit of grief. Instead, you can put your money across a lot of smaller loans more easily.
Secondly, when you do P2P lending, one strong idea is to spread your money not just across lots of loans, but different types of loans as well.
So you do personal loans, bridging loans, loans to landlords, loans to property owners who lease out offices or other commercial premises, and loans to wealthy individuals secured against their luxury fleets of yachts (or what have you).
And you do both secured and unsecured business loans. Unsecured loans tend to be to profitable businesses rather than asset-rich ones, so on average you can expect them to be different kinds of businesses too.
The point is that when one segment of the economy is doing badly, others are typically doing relatively well. Different types of loans will help spread your money into different areas, including different geographical areas too.
This eliminates the possibility of all your loans suffering badly due merely to lending to just one kind of borrower at the wrong time.
4. Getaway plan is a bit easier
Admittedly, this is one for people who've acquired a bit more skill and have a taste for numbers. But the point here is that if the economy is taking a real tumble, doing unsecured lending you can more quickly spot the deteriorating situation if you keep an eye on key figures.
More loans will start going bad than usual, so you could take this as a warning sign.
I absolutely wouldn't want you to panic and sell all your loans for a loss, but it gives you a warning to do some research and perhaps prepare a plan, or at least prepare yourself mentally for a period that might not be as glowingly prosperous as you were hoping.
5. Stable returns
All the above can lead to very stable returns.
Research from Liberum has shown that several forms of unsecured lending in the US and the UK delivered positive returns to banks for the best part of two decades, despite a couple of recessions, including the Great Recession.
All because setting interest rates, spreading risk and planning for bad debts is relatively easy.
Unsecured P2P lending looks strongly like, on average, it's going exactly the same way.
Did you know…?
Unsecured debts can sometimes – often quite easily – be turned into secured debts after the debt has gone bad.
Lawyers working for you and the P2P lending site to recover an unsecured bad debt can effectively ask the court to turn a borrower's more substantial assets into your security.
This protection isn't as strong as a secured loan and won't always land a result, but it is one potential tool in a P2P lending site's armoury.
On the flipside, a bank could do it to you too, with relative ease, if you can't pay off your credit-card bill! So do make sure you pay off your own debts before lending on P2P.
Read What Is Secured Business Lending? to find out why it can be so good – and what booby traps to look for.