Attractive rates have prompted many to lend through Zopa.
Personal debt as an asset class
Today I'm going to write about an asset class that has only become viable in the UK during the last four years -- personal debt. Basically you lend money to other people at an attractive interest rate, sit back and watch the profits roll in -- just like banks did for 300 years, until they got a little silly. Of course there are risks as well as rewards associated with lending money but I'm convinced this is a pretty good investment.
Zopa
In March 2005, Zopa launched in the UK. The company enables consumers to lend money to other consumers through rather clever technology. Borrowers register on the Zopa website, stating how much they want to borrow and for how long. They are then credit checked and assigned a credit category, from A* to C or Y (for young borrowers).
At the same time, lenders deposit money with Zopa and state what interest rate they are prepared to lend at. This decision is made easier by Zopa estimating bad debt and providing expected net returns for each credit category. Risk is reduced by lenders being able to limit their exposure to any single borrower. For example, someone lending £500 can spread it across 50 borrowers with a maximum of £10 with any single borrower.
Borrowers enter into a legally binding contract and repay the debt monthly by direct debit. If the repayments are missed, a collections agency gets involved and uses the same recovery process as that of a high street bank. So essentially you get to become a money lender with none of the hassle. Zopa charges you 1% of your disbursed funds to do all the work.
Impressive growth
In just four years Zopa has attracted more than 300,000 members (lenders and borrowers), has disbursed more than £50 million and is growing at more than 50% a year. Currently on the Zopa marketplace, lenders are offering £1.5 million.
Why has Zopa become so popular? Clearly borrowers get a good deal (especially as they can repay loans early with no redemption fee), and lenders get a relatively high rate of return. How high, though? Well Zopa reckons that, during the last twelve months, lenders have made an annual return of 8.1% before bad debts. I'm a bit cynical about claims like that and I arrived at my own estimate.
At the time of writing, having looked at actual rates being achieved, I think you could make 7.5% after bad debts. Zopa charges lenders 1%, so the rate before tax would be 6.5%. I reckon that's achievable for anyone placing money at the moment.
Based on the Zopa discussion forum (well worth reading for members' forthright views), rates higher than that are being achieved by self-styled 'Zopaholics', who seem to spend considerable time tweaking their rates to feather their nests and earn bragging rights among the cognoscenti. For the sake of balance it has to be said that many people earn lower rates.
Disadvantages and risks
Needless to say there are some potential downsides associated with becoming a money lender on Zopa:
1. Bad debts could be higher than Zopa's estimates, especially in the current climate of high unemployment.
2. The rates quoted above are only available on money lent out. It can take time to lend money at decent rates and re-invest interest and capital, and Zopa pays no interest on cash deposits.
3. In a period of rising interest rates, a lender will not benefit. Their rates remain at the level fixed at the start of the loan.
4. Borrowers can repay a loan at any time. A lender is unable to 'lock in' a rate of interest.
5. There is no secondary market for loans. Your money is tied up for as long as it takes to be repaid.
The only risk that really concerns me is the possibility of worsening bad debts so I'd factor in another half a percentage point off the return quoted earlier, giving a conservative return of between 6% and 6.5% pre tax. That's a comfortable premium over three-year deposit rates, but a lot lower than the rates being achieved a year or so ago.
The initial minimum investment is only £10. At that level, I feel you may as well give Zopa a trial, although I would not be comfortable having less than 20 borrrowers and I'd therefore recommend an initial investment of at least £200. Once in, I would bide my time until those inevitable moments when a shortage of lending funds and heavy demand for borrowing leads to higher rates.
Disclaimer: Tudor is a Zopa member.
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