How does bad debt affect your interest rate?
Since you are lending your money to a group of individuals or businesses, your return on investment and interest rate you have been quoted is based on the assumption that the customer repays their loans on time. However if they do not repay on time, they become ‘bad debt’ and this will cause the interest rate you have been quoted to fall. Lending to customers with bad credit will likely have a higher level of bad debt compared to lending to those with good credit. If you choose to lend to those with bad credit, you qualify to receive a much higher interest rate on your savings because you are taking more of a risk.
How do the companies minimise bad debt?
The compares we feature on our price comparison table want to work with borrowers who can afford to repay and they will carry out several measures to ensure this. Borrowers are always taken through various credit checks and identity checks prior to receiving a quote or a successful loan. One of our featured lenders, Zopa, says that it denies around 60% of applicants that apply for a loan.
The main thing that the company does to minimise the bad debt is to lend your money to lots of different borrowers with different loans over 1 to 5 years. This allows the company to diversify the money you have invested and limit the risk of bad debt. The quotation you have been provided with already assumes a percentage of bad debt and the fees to the company. The main peer-to-peer lender also usually has a specific fund in place in order to give you the interest rate you have been quoted. This fund is owned by a non-profit organisation meaning that the company has no legal right to it because it is entitled to you.
With hundreds of thousands of pounds in reserve, you should more or less be able to get the interest rate you have been quoted.
Whilst the contract proposed is between you and the person you are borrowing to, you do not have to chase up the individual personally for repayment. Each company has a collections team who will take the legal procedures to contact the borrower to recover the debt.
What if the company closes down?
In the unlikely event that one of that one of the companies we features ceases to trade, the loan contracts will still be applicable between you and the borrowers you have lent to. So whether you contact them yourself or through a third party organisation, you will be able to recover your investment.