Which P2P Lending Companies Boost Lender Returns With Default Interest?

When loans fall into arrears or even turn bad – i.e, they “default” – you continue to earn interest.

Most of the time, even if the borrower's property ultimately needs to be repossessed and sold, lenders get all their money back as well as all the interest they earned up to that point. The “cost” to lenders here has merely been that their money was stuck out on loan longer.

I think some lenders are probably glad that they didn't have to find a new home for their money during that period and that they simply continued to earn interest on it. Provided that all usually ends well!

Bad debts can reward you even more

But late-paying borrowers are usually charged penalties on top of their standard interest, which might be ongoing penalty interest, a flat penalty fee, or both.

Usually, individual lenders like you and I don't get this money, as the providers don't pass it on.

To an extent, this can be reasonable, in a way. The fees and interest are often at a low enough level that they probably only cover the additional costs to the provider in chasing the bad debts.

But you'd hope that providers are putting sufficient penalty interest into the loan contracts to make borrowers think even more about prioritising repayment.

Also, when the fees and interest are genuinely penal, you would be right to believe that lenders should get it, since it's our money that's at risk.

After all, the penalty is to make up for the increased risk to the people who lent the money that arises when borrowers who fall behind, since they collectively become less likely to repay in full.

The provider is not risking losing anything from the bad debt, we are.

Indeed, there's at least one ruling from the High Court on this now that forced a closed provider to be liable to repay millions to individual lenders in default fees that it raked in.

Who pays out penalty interest and fees to lenders?

Here are the providers that 4thWay's specialists are aware of that pay out additional penalties to lenders using their online platforms.

(There could be more of them that simply haven't informed 4thWay and/or don't supply us with the additional level of data on penalties.)

Proplend

Proplend* (read Proplend Review) pays out not just penalty interest but also penalty fees to lenders.

It starts collecting this quite early, meaning you often earn extra even on loans that might technically have defaulted but where there's no real danger that the borrower won't actually repay.

Detailed data shows the result of this: the equivalent annualised rate paid to lenders ends up being typically 3-4 percentage points more on loans that technically default! So lenders typically boost their final returns dramatically on these loans.

On a side note, Proplend is unusually “honest” in that it also pays out to lenders whatever savings rate the bank is paying when you have any unlent cash sitting in the client money account. This is even more rare than providers paying out penalty interest and fees to lenders. Savings interest is not usually a vast amount, although more these days with higher bank rates.

CrowdProperty

CrowdProperty (read CrowdProperty Review) pays a level of default interest that has actually seen lenders, on average, earn a few tenths of a percentage point per year extra over what they were expecting. In other words, the penalty interest more than covered any small losses.

4thWay's specialists say this will not be the case in the near future, as they expect that lenders on average will earn less than targeted. However, the penalty interest will help offset any shortfall and overall lending results will still be resoundingly positive.

Somo

While Somo* (read Somo Review) provides a lot of data to 4thWay, it doesn't yet quite provide sufficient information for 4thWay's specialists to see the impact of its default interest, which it pays out to lenders.

Anecdotally, Somo states that default interest has boosted lender returns quite substantially.

CapitalStackers

CapitalStackers* (read CapitalStackers Review) takes the view that carrot is better than stick and it doesn't want to “break the camel's back” by charging default interest to borrowers unless absolutely necessary.

However, when it does charge default interest, it all goes to its lenders through its online lending platform.

HNW Lending

HNW Lending* (read HNW Lending Review) pays default interest to lenders.

We have no breakdown of data on it, but it has previously told us that it rarely charges it to borrowers, even when they technically default, so there's not often any additional interest to pass on to lenders.

However, the penalties are high, so it adds up when HNW Lending does collect it.

Invest & Fund

Technically, Invest & Fund* (see Invest & Fund Review) pays substantial default interest to lenders, although just a couple of loans collected this interest from borrowers very briefly before the borrowers repaid.

Kuflink

Kuflink* (read Kuflink Review) has historically not paid out penalty interest to lenders, but it is just starting to do so. We'll let you know when we have some data on this.

Very useful to know!

If a provider charges penalty fees and/or interest but doesn't pay it out to lenders, there's a conflict of interest. It means they are making more loans on loans that don't perform well!

In a worst-case scenario, they might potentially earn more money – at least over the short term – by deliberately taking on worse loans and then raking in penalty fees.

They might even drag their feet in recovering those debts. Slower attempts to claw back the loan reduce the chances of a full recovery for lenders.

4thWay's specialists point out that all businesses – in all industries – have conflicts of interest. So it's important to assess the potential scale and likelihood of any conflict on an individual basis.

A little surprisingly, when looking at providers that have closed down since this industry took off in 2005, there's very little to show a pattern in terms of this specific conflict of interest leading to problem loans and severe losses.

That means that most of the closed providers had this very conflict of interest, but on closure lenders usually got all their loan money back anyway, along with all the expected interest.

So normally – and by itself – it's not a big deal.

However, the closures that ended with the worst results for lenders also had conflicts of interest and they were sometimes severe. Some of those conflicts were specifically regarding default interest and other times it was regarding other conflicts.

The most notable case was Lendy, which had a lot of other warning signs.

That's why, when weighing a potential conflict of interest regarding default interest, you need to see whether other things smell bad too.

The more issues you find about a provider – the more things that alert your instincts or rational mind – the more you should be concerned about them. And therefore the more cynical you should be about that provider's conflicts of interest.

Further reading

There’s No Such Thing as “No Lender Fee”.