Zopa - Do early repayments affect your expected return?

shockeroo

I'm trying to work out if the fee-free early repayment option on Zopa loans reduces your expected return as a lender. If we assume that only lower-risk borrowers (within any given risk-grade) repay early, then does this not leave you with a higher risk of defaulters and lower expected return?

On a related note, has anybody done some number crunching on Zopa lending and expected returns after tax + bad debt?

(Apologies if this has been tackled elsewhere, I could not find a thread that dealt specifically with the fee-free repayment affecting returns.)

Gorgeous_George

Happy New Year shockeroo

Yes, a lender's returns wil be lower as the early repayment reduces the interest payable. It is great for borrowers of course and lenders get to lend the money again so it's not bad for them.

My average gross return is currently 8.47%. I pay Zopa 1% so 7.47% will be taxable. After paying basic rate tax my net return is 5.98%. That is pretty good in my opinion.

Bad debt is another problem. At the moment individual lenders cannot offset the bad debt against tax. at the moment I have one problem borrower (out of 459)who owes me 0.43% of my total. This makes my return 5.55% but there is a chance that I will get more bad debt (been with Zopa since February 2009) just as there is a chance that my problem borrower will redeem himself.

You can also earn £££ by referring friends and acquaintances. There if a referral thread on MSE with more details.

GG

jamesd

If you let me know what return after fee, tax and bad debt allowance you want and what tax rate you expect to pay I'll tell you the rate to set to get that return after allowing for the effect of tax on the bad debt allowances. Zopa's lending screens still assume 0% tax, so they are wrong for most people with the current tax treatment.

Yes, repayments lower returns on average but not as much as you might expect if you're looking to keep the money invested. What happens is that they repay and that money then goes back into your pot of money available to lend. You lose interest only for the time it takes to relend the money. That relending could be at a higher or lower rate depending on what the market rates are there at the time it happens. This relending does increase the time your money is tied up, of course, because it starts a new loan term. After about 18 months I've lent out about £6,000 and had about £2,000 returned, from a mixture of normal and early repayments. About £1,300 of that returned money is in closed loans, from early full repayment. This is when trying to lend to the 60 month markets, so those aiming at 36 months might expect more rapid early settlement.

Also you should note that the loan terms aren't guaranteed for investors. In the case of an IVA the IVA agreement could easily turn a three year loan term into a 50%+ capital loss and many more years than expected to get the remainder back if the borrower keeps up with the repayments. Beats a straight default but still does leave some money tied up. For example, one of my 60 month loans will end up repaying 48% of the capital if the payments are maintained until the end of the IVA. The first of those payments won't happen until May 2010, some eight months after the IVA was agreed.

Use great care when reading the returns for one year or less. That's because it takes three months for a loan to be declared in default. There will be some early defaults from people who never intended to repay, not many, but then they will increase over the first couple of years before perhaps reaching a steady state after that. You always need to remember that Zopa returns start out as good as they can possibly get, then get worse over time as the bad debts emerge.

Note also that Zopa's bad debt estimates are just estimates. The period from one year ago to two years ago is way above the predictions. Zopa periodically adjusts its rules to try to stay on target, but you do need to be prepared for the unexpected. That could be good rather than bad, you just can't know.

Here's a snapshot of my loan book today:

Arrangement 18 loans 14.92 % interest rate £180.00 lent £28.29 capital paid £18.17 interest paid
Closed 95 loans 13.99 % interest rate £1,310.00 lent £1,310 capital paid £68.74 interest paid
Collections 3 loans 16.04 % interest rate £30.00 lent £8.56 capital paid £1.61 interest paid
Default 14 loans 18.52 % interest rate £140.00 lent £7.97 capital paid £8.32 interest paid
Withdrawn 311 loans 14.21 % interest rate £4,400.00 lent £786.77 capital paid £484.07 interest paid

Withdrawn loans are the ones that are performing as expected or are only a little late in payment. "Loans" is £10 units, not individual borrowers. I routinely lend more than £10 per borrower using a method called Easteregging, offering chunks at ever-increasing interest rates. This gets a higher average return because larger loans take up money at the higher rates.

All but £10 of the default money is from two Listings loans. Arrangement and collections have a higher than average Listings participation as expected but are more evenly mixed. Don't take this as meaning Listings are all bad. One of my earliest loans was a Listings loan for 36 months at an average rate of 19.96 % with £200.00 lent to one borrower. So far I've received £75.63 in capital and £40.90 in interest on that one with every payment made on time. Price for the risk you're taking and don't offer less than makes sense for the risk.

As you might see from the rates I'm getting I also try to lend only at good lending times, when there's a shortage of money in the Zopa markets. Picking the time to lend instead of chasing rates to the floor when there's a lot of money on offer is one of the ways you can substantially improve likely returns. Using the 60 month markets a lot also helps to improve the rates, since many lenders don't like that term. I put getting good rates ahead of getting lots of money lent out in my priorities. I can use corporate bond funds or other investments to get 8%+ yield so I don't see the point in using Zopa and seeking less than 8-10% given the alternative risk-based investments available and the tie-in.

Declaration of interest: I both have lending offers in the Zopa market and have many £10 loans from investors via Zopa.

Gorgeous_George

james

jamesd wrote: »

If you let me know what return after fee, tax and bad debt allowance you want and what tax rate you expect to pay I'll tell you the rate to set to get that return after allowing for the effect of tax on the bad debt allowances.

Can I borrow your crystal ball? How do you know the bad debt rate that shockeroo WILL experience?

Am I right that you seem to have almost 8% of your loans in trouble? If so, why do you feel qualified to give advice?

jamesd wrote: »

Here's a snapshot of my loan book today:

Arrangement 18 loans 14.92 % interest rate £180.00 lent £28.29 capital paid £18.17 interest paid
Closed 95 loans 13.99 % interest rate £1,310.00 lent £1,310 capital paid £68.74 interest paid
Collections 3 loans 16.04 % interest rate £30.00 lent £8.56 capital paid £1.61 interest paid
Default 14 loans 18.52 % interest rate £140.00 lent £7.97 capital paid £8.32 interest paid
Withdrawn 311 loans 14.21 % interest rate £4,400.00 lent £786.77 capital paid £484.07 interest paid

GG

jamesd

Gorgeous George, I offered to work out the rate needed before bad debt allowance and the tax treatment of that allowance. Zopa's lending screens assume everyone is paying no tax, so for tax payers they overstate the expected return by understating the required bad debt allowance.

I don't have a crystal ball to know whether the actual bad debt rates will be as predicted by Zopa and expressed in the bad debt allowance, much higher, as it was in the 12-24 month range, or lower. That's part of why using Zopa is risk-based investing, more comparable to stock market and corporate bond investing than a savings account.

Having bad debts does give me some reason to want people to get the bad debt allowance right.

The original lent amount of loans that I have that are in arrangement, collections or default amount to about 6% of my initial lending, still comfortably below the total defaults expected over the mostly three to five year life of the loans. At inception of the loans my annualised bad debt allowance was around £190 a year (that's the total of the allowances for all loans, including the allowance I use for listings). The loan book looks likely to end up with defaults below the accumulated bad debt allowance, though a troubled economy could change that. Most of the defaults are from people who appear never to have had any intention of paying the money back.

If I recall correctly you limit your lending to almost exclusively the A* and A markets, which have much lower bad debt expectations than the B, C, Y and listings areas? You shouldn't be surprised that in your own loan book composed of only the very lowest risk areas you see lower default rates than someone with a blend across all markets and listings. A rapidly growing loan book can also mask the effect, particularly when it's a book less than a year old, which won't yet have had time for many loans to start failing to perform.

You might want to try seeing how well your non-performing loans match the bad debt allowances on your loan book. That's one way of comparing while having loans from markets with very different bad debt allowances.

Alternatively, if you'd care to post your own loan book details by market, I'll do the same for mine for those markets and we can compare for the same markets.

It's worth remembering that outside Listings, it's Zopa that does the underwriting and hence Zopa that is responsible for getting the bad debt matching their allowance. Both the listings and markets lending I've done are performing reasonably on track for the risk level of the places where I've done the lending. I've no reason to be unhappy with the performance of Zopa's underwriting for my own markets loan book, nor to be greatly so with my own and their combined result in Listings (given the around 8% annualised bad debt allowance I use in Listings).