Get email notifications on new posts:
Whether you are new to loan financing, or just confused about some of the terms – this post aims to bring you clarity. I’ll attempt to explain everything as simply as possible, starting with general loan terminology and progressing to terms used specifically on loan financing websites (often referred to as P2P lending).
Bear in mind that different platforms use slightly different wording, but the general principals are similar. Let’s get started!
Pretty self-explanatory. Common types include mortgage loans, car loans, personal loans, business loans, real estate loans, and invoice financing.
(Invoice financing is when a business either sells an invoice for a due payment, or takes a loan secured against such invoice.)
Loan Term / Duration
The total duration of a loan. With an ongoing loan, it’s more interesting to know the remaining term, based on the loan maturity – the date of the final payment.
The amount borrowed. With an ongoing loan, it’s also interesting to know the outstanding principal – the amount yet to be repaid.
The sum added to the principal as payment to the lender.
Borrower APR (Annual Percentage Rate)
The annualised percentage of interest (relative to the principal) paid by the borrower. It’s best to include borrower fees in this calculation to measure the effective APR. higher APR usually represents higher risk.
Net Interest Rate (for investors)
The annualised percentage of interest offered to investors for a specific loan, after overhead and fees. In some circumstances the effective rate might change throughout the term of the loan, so for ongoing loans it’s better to use YTM – Yield to Maturity, the actual interest the loan will incur from now till it ends.
ROI (Return on Investment)
Yet another confusing term, ROI is a measure of the total return on a loan throughout its duration. It’s difficult to compare the ROI between loans with a different duration, which makes this indicator rather meaningless in my view.
Portfolio NAR (Net Annual Return)
The standard way of stating the return of an entire investment portfolio, after fees, taking into account deposits and withdrawals. There are different ways of calculating this, the most common being the “XIRR” formula.
Amortisation Method / Schedule
“Amortisation” is the gradual repayment of a loan or debt. Loans with a term longer than one month are mostly repaid in periodic instalments (usually monthly). There are different ways of calculating these instalments. I won’t go into all of them, but give two examples:
1. “Bullet” is an amortisation method where only the interest is repaid periodically. At the end date of the loan, the entire principal is repaid at once. This is used mainly in business loans.
2. “Declining balance” is when instalments consist of part principal and part interest, and are all of equal sum. Remember: When part of the principal is repaid, the outstanding principal shrinks. To maintain equal payments, the ratio between principal and interest shifts gradually with each instalment. This is common in personal loans.
I know, it’s a complex topic. Just remember that different amortisation methods result in different distributions of payments. Most platforms display some kind of amortisation schedule.
“Current” – All due payments have been made, and the loan is performing as planned.
“Grace period” – It may take a few days to process payments made by the borrower. For this reason, some platforms allow a few days’ “grace period” for a late payment before the loan is considered “late”.
“Late / Delinquent” – When a payment is overdue. There are often “tiers of lateness”, e.g. 1-15 days late, 16-30 days late, 31-60 days late.
“Default” – When a payment is overdue for such a long period that it seems unlikely to be repaid – usually 60+ days. At this point the loan agreement is terminated, and debt collection begins.
(Another term you may encounter is “Non-performing loan”, which can refer to either a severely late loan or a default loan.)
“Bad debt” – As long as a loan is default, recovery efforts persist. When there is no more hope for recovering some of the loan principle, this sum is considered lost, and collection efforts are ceased.
Buyback Guarantee (in case of default)
Some platforms and loan originators offer to compensate the investor if a loan defaults. The compensation may be full or partial, and may or may not include the due interest, depending on platform and loan originator. This guarantee adds an important layer of safety, but only insofar as the guarantor is able to uphold it.
Money-back / Sell-back Option
Generally, money lending doesn’t offer much liquidity: You can’t free up your money at whim. However, some platforms offer investors the option to sell a loan back to them if they need to free up cash quickly (often for a fee).
Some platforms (especially those without sell-back option) allow investors to sell loans to one another to free up cash. This is referred to as a “secondary market”. Of course, you can only sell loans that other people are willing to buy.
When the borrower pledges an asset as collateral, to be repossessed by the lender in case of default. This provides a way to recover the debt, thus reducing the riskiness of a loan.
LTV – Loan to Value Ratio
In secured loans, the loan amount is compared to the value of the pledged asset, e.g. a car or a house. The lower the LTV, the safer the loan, since selling the pledged asset would easily cover the debt.
When a limited-liability company goes bankrupt, its owner isn’t necessarily held responsible for the company’s debts. To amend this, business loan providers often demand a personal guarantee by the company owners to repay the loan in case the company is unable to. Of course, the owner might not have the necessary funds to repay the debt – but at the very list, the personal guarantee should make them think twice before declaring their company bankrupt, taking on its debt.
When some of the money you deposit into an investment platform is lying around unused, usually because all the loans have been funded. If it lasts more than a few days, it becomes an issue, as you’re not earning interest for this money.
I know, it’s a long list and a lot to process! But once you familiarise yourself with those terms, you should feel comfortable on any loan financing platform, aaand be able to understand my future posts. 🙂