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What Is The “Bad-Debt Rate”?
One of the first measures of risk in a P2P lending company is its historical – or “actual” bad-debt rate. This shows how many pounds of loans have gone bad as a proportion of the money lent.
The bad-debt rate is variously called the “loss rate”, the “credit loss rate”, the “default rate” and probably a few more I've forgotten right now or never heard of. (Although, to confuse you some more, some businesses use the “default rate” to mean something else!)
How the bad-debt rate is calculated
The simplest way the bad-debt rate is calculated is as an annual average bad-debt rate. If £10,000 has gone bad in a year and there has been £1,000,000 in loans, that's a 1% annual bad-debt rate.
This has the advantage of showing you in one figure how low bad debts are compared to other P2P lending companies.
Lifetime bad debts
Another common way the P2P lending companies calculate the bad-debt rate is to take the lifetime bad debts based on the year the loans were issued.
So loans issued in 2012 might so far have built up total bad debts of 4%, those in 2013 have built up 3% and those in 2014, 2.5%.
This means that after five years you'll have five separate bad-debt rates to think about, which isn't so straightforward. However, it is particularly useful if you are not planning to lend regularly and re-lend repayments you receive, since you can get an idea of the variation you might expect.
What loans are classed as bad debts?
The financial regulator doesn't lay down rules about what loans a P2P lending company has to class as bad debts. This can mean that some P2P lending companies use looser definitions than others.
The members of the Peer-to-Peer Finance Association* define it as:
- Any portion of a loan that has not been repaid 120 days following a repayment date. Mat Gazeley of Zopa told us that “generally”, at this point, it's the full outstanding loan that now counts as being a bad debt, not just the missing payments.
- All costs in relation to chasing and recovering a loan that is late or not being paid, where such costs are not recovered in full from the borrower.
- Any loan amount where there is a reasonable expectation that the borrower is not going to repay the loan on time (e.g. the borrower has gone bankrupt).
FundingKnight has a strikingly different, and less conservative, definition. Only parts of a loan that have been written off completely count as bad debt in its statistics. Loans that FundingKnight is still trying to recover, seemingly no matter how poor the outlook or how long the debt has been unpaid, are not included in the figures.
In our comparison tables, to make FundingKnight's bad-debt rates more closely comparable with other P2P lending companies, such as those in the P2PFA, we add its loans in debt recovery to its write offs when estimating its bad-debt rates.
On the other side, UK Bond Network takes a more conservative view than the P2PFA: any loans over two weeks late in making a repayment are classed as bad debts.
*Commission, fees and impartial research: our service is free to you. 4thWay shows dozens of P2P lending accounts in our accurate comparison tables and we add new ones as they make it through our listing process. We receive compensation from Funding Circle, Landbay, Lending Works and RateSetter, and other P2P lending companies not mentioned above either when you click through from our website and open accounts with them, or to cover the costs of conducting our calculated stress tests and ratings assessments. We vigorously ensure that this doesn't affect our editorial independence. Read How we earn money fairly with your help.