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How Much You Lose If A P2P Lending Website Goes Bust
There are all sorts of reasons why a P2P lending website may no longer be able to pay its bills.
It might run out of start-up funding before it has started to earn enough money. It might succumb to better, more nimble competition. It might itself borrow money that it ultimately is not able to pay back.
It might just be bad at what it's supposed to be good at: finding and selecting a lot of quality borrowers and sticking to that.
Whatever the reason, a P2P lending site going bust could either cause you no losses or you might not. It could sometimes also have another consequence, which I'll come to later on.
Get bought out or be closed down
A P2P lending website that is struggling to pay its bills could be bought out by another, more successful operation and lenders will continue lending as normal.
This has happened already, most notably when P2P giant RateSetter took on GraduRates loans, which enabled its lenders to have an orderly wind down.
If it isn't bought up, a P2P site that can't pay its bills might have to close down.
What happens next?
There are a few scenarios that can occur from this position.
The Financial Conduct Authority expects P2P lending websites to have a funded plan to wind down existing loans in an orderly fashion. That means they need to be ready to keep receiving the borrowers' loan payments, for the repayments and interest to then be paid out to individual lenders, as well as to chase late payments and bad debts.
For that purpose, P2P lending websites are now required to have locked safely aside at least £50,000, with larger sites requiring even more.
P2P sites also need to have lined up up administrators or trustees to run down the existing loans. The administrators will continue to receive repayments on your behalf and see to it that bad debts and late payments are chased.
Over the past 12 months, the regulator has been taking a very keen interest in P2P sites' winddown plans as part of its process for giving them all full permission to run P2P businesses.
Even if these backstops work properly, it might not save us lenders from all losses, as I will explain in a moment.
Here are a few scenarios on how a failed P2P lending website might impact its lenders:
The best scenario
So far this has always been the case, to my knowledge – the loans in closed P2P sites are winding down smoothly and all the investors are getting their money back.
The only losers are the entrepreneurs, investors and employees of the peer-to-peer lending websites, rather than people like you and me who are lending our money.
Lenders take a small hit
Sometimes lenders just might not come out of it with all their loan money returned.
Generally speaking, it is not expensive merely to administer ongoing loans.
Some of the more expensive costs, such as sales and advertising, are in the past and they are not necessary for winding down existing loans.the cost of merely administering ongoing loans is lownot high.
Those running small P2P lending sites could even wind down the loans in their own spare time.
Yet when administrators come in to wind things down, they have to be paid, and the cost of collecting bad debts, chasing payments, answering queries and so on will usually have to be covered from the money set aside for this situation.
Failing that, we can expect the administrators to pay themselves and their expenses with any ongoing fees that the P2P lending website would have received from the borrowers or lenders.
If those fees also don't cover all the costs, we lenders will see the costs taken from us, and that will mean that the interest we are earning will be reduced.
If the costs are even higher that, perhaps due to a very disorganised back office structure or lots of problem debts to chase, we individual lenders might find that all the interest is used up and we just get back, say, 95p for every pound we lent.
Hopefully we have already made enough money on previous, completed loans to cover the difference! If we earned around 5% interest the previous year, for example, that should roughly cover this hit so that we don't actually lose money overall.
The longer we have been earning interest for, the lower the chances that we will make an overall loss.
Lenders take a large hit
It is possible that a peer-to-peer lending website has not followed the regulator's instructions to take “reasonable steps to ensure continued administration of existing loans in the event of the firm failing”. This might possibly mean that it has even lied to the regulator about its winddown plans in order to win its backing.
In that event, you might lose somewhat more than 95p in the pound.
Is this likely? I'd say not. With £50,000 or more, plus any potential other ongoing fees, plus the interest you earn, making substantial losses doesn't make sense the vast majority of the time.
Consider that the reason banks and other businesses have found lending so profitable is because the ongoing costs of running loans are considerably less than the total amount lent.
So, say there is £1,000,000 in loans outstanding. Clearly the cost of administering those loans is a fraction of £1,000,000, or banks as we know them would never have existed. Put another way, it can't possibly cost a bank £1,000,000 to lend £1,000,000!
Therefore, losing a large amount due to a properly arranged, but unfortunate, P2P site going bust doesn't seem like an event that should happen very often, if at all.
There are other consequences to a P2P site going bust that are much more likely to happen:
- You should prepare to be tied in for longer, since the payments back to you could be seriously delayed.
- You probably will find it difficult or impossible to sell your loans early, if the P2P site has a market for buying and selling existing loans. You should even expect that that market will be shut down completely.
What can you do
The single best thing you can do to reduce this risk is spread your money across many P2P lending sites.
If you're still concerned, you could look for P2P lending sites that are currently profitable (i.e. they are making money), which arguably are less likely to go bust, or you could look for the P2P lending sites that are being supported financially by larger companies or big-name investors.