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What You Need To Know About P2P Bridging Lending
Perhaps half of P2P lending companies in the UK offer bridging lending, so it's an extremely popular type of property loan to lend in. It's not only a very distinct kind of lending, but the risks vary massively between different providers.
Today, I'm writing about this type of P2P lending's distinguishing features.
So what is P2P bridging lending?
P2P bridging lending is when you lend to a property owner who needs either a short-term or urgent loan against the property.
There are lots of reasons why borrowers might need this. For example, they might need the loan to make a rapid property purchase at auction. Eventually, that borrower might shift to a regular buy-to-let mortgage, perhaps after they've got tenants into the property.
For more on what these loans basically are, you can see our definition of bridging loans. I'm going to look beyond those basics to important features for you as lenders.
How long and how big are these loans?
These property loans are intended to be for short periods, because they're not cheap for borrowers. They are typically for three to 12 months.
The size of these loans varies dramatically. They can be as small as tens of thousands of pounds or in the millions.
Different P2P lending companies focus on different ranges; for example, one might be bringing in loans from £50,000 to £500,000 while another looks for deals between £250,000 and £2 million.
At present, the target loan size that each of the P2P bridging lending companies go for doesn't appear to have a significant impact on lending results. I mean, it doesn't seem like smaller P2P bridging loans are substantially more likely to turn bad or vice versa, based on the information we have at present. But 4thWay's specialists continue to acquire more data to look for patterns.
What types of properties might you lend against?
You might find bridging loans on residential properties or on any type of commercial property. The latter could be buildings that accommodate fairly ordinary businesses, such as offices, shopping centres, restaurants, hotels or care homes. Or they could be football stadiums and other exotic places.
You can also get bridging loans on land that has no property on it.
How much do you typically lend versus the property valuation?
Depending on where you look, you could limit your lending to just 50% of the initial valuation, e.g. with Proplend* (read review). On the other side of the scale, LandlordInvest (read review) has approved a couple of bridging loans for as much as 80%. Those heights are seen here and there from other specialist bridging lenders, although it's pressing the absolute limits of bridging lending in P2P.
What are the risks in P2P bridging lending?
There are some risks that are peculiar to bridging:
- Borrowers are often temporarily over-extended. For example, they've purchased a property using a bridging loan, because they're in the middle of a chain in selling another property. They therefore have more debt and property than they're usually able to handle. They're looking to sell a property as quickly as possible to get the overall debt level back in order.
- Borrowers pay high interest rates and fees. I'll write more on rates specifically later, but I bring it up now because the high rates themselves increase the risks that borrowers have difficulty paying what they owe.
- There can also be an element of what 4thWay specialists call “moral hazard”. Borrowers who are willing to take on large amounts of additional debt at high rates are possibly more likely to take more chances.
When the bridging loan is against a commercial property, it can come with additional risk. Commercial properties can sometimes be harder to value. Rather, it's harder to understand or predict whether the properties will keep their value, and so the valuers require additional care, expertise and local understanding.
Here's an example: a restaurant with a bridging loan might rely on workers from a nearby office to make a profit. If the office shuts down or relocates, the restaurant might have to close and it could be hard to sell the land and building for the expected price, because any new owner might have the same problems with their restaurateur tenants.
Furthermore, in the UK at least, residential property prices are supported by lon-term supply problems that have been getting worse for a very long time. Simply, not enough houses have been built. Commercial property prices on the whole don't have that huge support from undersupply. Indeed, in some cases you might even be concerned that supply is too high.
All the usual risks of property lending are on top of these bridging lending risks. The most prevalent one is that a loan turns bad and you're unable to recover the full loan amount when the property is forcibly sold. Take a look at the The 12 Key Peer-To-Peer Lending Risks.
Your position in the queue
As with all property lending, understand your “rank” when looking to get your money back on a bad debt. Usually in P2P lending you're first line, but not always.
If you're lending 75% of the property valuation, it will probably make a huge difference whether you're first in line or later. Those coming before you – which will typically include a high-street bank – probably have lent a lot more than you, but their money is safer.
Let's say they have lent 50% of the property valuation. You and other lenders through the P2P site have lent the remainder, taking the total debt to 75% of the valuation. Let's say the loan now turns bad and the property needs to be forcibly sold. Then let's say there's a crash in property prices averaging 15%-20%, but the borrower is forced to sell this particular property for 35% less than its initial valuation, after deducting costs. That means that 65% of the total lent to the borrower, by all lenders, is recovered.
The banks ahead of you get all their money back, as it's more than the 50% they lent.
You, along the others lending with you through the P2P lending company, lent an additional 25% of the property's valuation. But only an additional 15% was recovered. (50% + 15% is 65%, the total recovered.) This means that for every £25 you lent, you get back £15. Put in rounder numbers, for every £100 you lent, you get back £60.
In contrast, if you had been first in line while lending up to 75%, you would have got back £65 for every £75 you lent on that loan.
Somewhat offsetting all this, P2P bridging loans are rarely, if ever, secured against the borrower's main residence. This means you don't have the risk that a judge will refuse to throw out the borrower's family. If that could happen to you, it would mean that you would have to wait a long time to be able to sell the property and recover your money. Not an issue here.
How many P2P bridging loans get into trouble?
P2P lending companies have shown widely different results in terms of the proportion of loans that suffer issues and turn bad. It comes down to how selective they are.
P2P bridging lending providers that seem to be ambitiously driven by growth tend to have looser standards and can have around a fifth of loans fall very late or turn bad, even during good times. These loans typically need to be passed to lawyers to formally recover the debt.
Providers that focus on high-quality selection far above everything else typically have a small number of loans, or even zero, that get into trouble during good times.
As I said, that's a big range of bad debts!
Recovering bad debts
When a P2P lending company is loose in accepting borrowers, it needs to be quick at reacting to bad debts.
It will still usually take months or even years to recover the debt, but in moving fast with legal action you normally expect them to recover the full debt, or most of it, and typically with interest on top for the whole period the debt was outstanding.
But this is not a given. It depends a lot on the competence of the P2P lending company ro spot these issues and react fast.
Watching for renewed and extended loans
The easiest way for P2P bridging lending companies to bury their heads in the sand over bad debts is to simply allow borrowers to roll over their loans into new loans with few questions asked, or to extend the deadline on existing loans.
All but the lowest-risk bridging lending typically comes with quite a lot of these so-called “refinances” or with extensions. Sometimes loans are extended several times. This is legitimate and there is usually a good reason for the borrower asking for the additional time and for the P2P lending company to approve it.
So one of the tricky parts for lenders in bridging loans is to find out how much this is happening and how much is reasonable. And how much is hiding problem debts by kicking them down the road.
The best way is to look back at the P2P lending company's historical record. Look to see whether, in previous years, refinanced and extended loans have ultimately been repaid in full.
Penalty interest – who earns it?
P2P bridging lending, much like development lending, is an area where borrowers often have to pay very high penalty rates when they fall late. This is called “default interest”.
Lenders should take note who is paid this default interest: is it them or is it the P2P lending company?
If it is the latter, this can cause – and indeed has caused – providers to enjoy bad loans and even string them out for longer. It's a perverse incentive to them to actually want more bad debts. Something for lenders to watch out for, on occasion!
Similarly, directors and founders of P2P bridging companies sometimes enjoy borrowing through their own companies or through their own online lending platforms.
When you see this, you need to be satisfied that it's reasonable, that you believe the director is paying a fair interest rate, that the security is sufficient and that the debt will be repaid.
In bridging, borrower quality can mean having borrowers with large amounts of other property, cash or possessions. But it mostly means that they have a lot of income and a great historical record in similar property lending.
Loosely speaking, there are typically two types of P2P bridging company. There are those that care about all these aspects of borrower quality, or they don't because they focus just on the property itself.
Where a P2P lending company doesn't work hard to establish how great the borrower is, you often also see a more loosy-goosy attitude to approving loans. For example, it might not always get a fresh, independent valuation of the property. It might use an older one instead, e.g. when the loan is for a very small amount compared to the valuation.
Perhaps surprisingly, that is absolutely okay, provided individual lenders are aware of this and provided the interest rates or other risk-reducing features are substantial enough to cope with any substantial misvaluations. It also should remain a minority of loans that have such shortcuts.
As you can probably imagine by now, the P2P lending companies that have the highest number of loans turn bad are usually the ones that don't consider borrower quality to be roughly as important as the property itself.
What borrowers pay
It takes a lot of effort to acquire and assess new borrowers for these sorts of loans, so the costs of doing so are high.
On top of that, borrowers need to pay for the fact that bridging loans come with the risk of delays in repayment and that there's at least a handful of risk that lenders won't recover all their money when loans turn bad.
For both these reasons, borrowers pay interest rates and fees combined (the “APR”) that start from around 10% per year and go up to around 25% per year. Most typically, total annual costs to borrowers are in a narrower range of the high teens to low 20 percent area.
Lending rates range from 6% to 14% per year. This is much lower than the total annual cost to the borrowers.
I've already explained the main reason in the previous section: the cost of acquiring and assessing borrowers. P2P lending companies have to put a lot of resources into that, just as other non-P2P bridging lending companies have to do.
4thWay's specialists tell me there is probably a secondary reason. Budding P2P bridging lenders typically appear to want to hit profitability themselves earlier than some other types of P2P lending companies. To do this, they need to take a greater slice of the pie.
Even so, lenders are still getting the vast majority of the profits from these loans, far more than the P2P companies get after all their costs.
When you are going to be earning closer to 6% than, say, 10%, you really need to be making sure that your risks are being very well contained. This might partially mean that the bridging loans you're signing up to are the kind that are a lot less likely to turn bad in the first place. But it's also likely to mean that you are easily able to spread your money across a large number of loans.
Read the Proplend Review.
Read the LandlordInvest Review.
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