Investing In Microloans 🤑 How Does It Work? - YouTube

Hi and welcome to another video.

Today it’s all about investing in micro-loans.

If you are a P2P investor it’s likely that you are currently actually investing in microloans.

Or you have done it in the past at some point.

Microloans are short-term consumer loans or as many people like to call them - payday

loans.

Anyway, we have got the question from our community and investors are wondering why

they only get 11% interest from payday loans while the lender charges anywhere between

40% and 3500% annual interest to the borrowers.

So in this video, we will dive deeper into payday loans and give you a bit more information

that may impact your decisions to invest in this asset class.

My name is Jakub from P2P Empire, and if your goal is to become a more educated investor

consider subscribing to this channel and also hit the like button to see more content like

this in the future.

So what’s today’s video all about?

First, I will give you some introduction to the loan type, next we will talk about the

pricing of the loans, some risks you should consider, pros and cons and we will round

up the video with some takeaways.

So what are payday loans?

Payday loans are short-term consumer loans.

It’s basically a loan, with a loan term of around 30 days.

The loan amount varies typically between €100 and €1,000.

The interest ranges between 40% and 3500% per year.

Those loans are unsecured which means that they are not backed by any collateral.

This means that the lending company cannot sell any collateral if the borrower does not

repay the debt.

If the borrower doesn’t repay the loan, the company will likely charge the person

additional fees, send the person several reminders and at some point sell the claim to the debt

collector.

You should know that if the borrower does not repay the loan, he or she will lose its

credit score and in many societies, this can have a negative impact on their daily lives.

Borrowers who don’t repay their loans can expect regular calls from the debt collector

and usually, those talks are not comfortable.

Non Paying borrowers will also likely be denied when buying a car on leasing or even ordering

a credit card.

Now, you might be wondering what are the requirements for the borrowers to obtain such a loan?

Well, the creditworthiness of the borrower needs to be positive otherwise he or she gets

denied.

At the end of the day, the lending company wants to lend money only to people where the

chances are high, that the borrower will be able to repay the loan.

In most cases, the borrower needs to be over 18 years of age, in some countries like Poland

the minimum age is actually 19.

Borrowers also need to provide their income reports and they cannot have a negative entry

in the national debt collector registries.

When it comes to the requirements, loan term, and APR, most of the time you can check the

terms and conditions on the website of the lending company.

There is usually a long FAQ list, which will answer most of the questions borrowers might

have.

Lending companies are required to disclose the APR in several jurisdictions.

It’s, however, not always the case.

When we for instance looked at this lending company’s landing page in Vietnam, we could

not find any APR.

So it seems like it always comes down to the regulators and the markets where the lender

is operating.

At the beginning of the video, we mentioned that the APR for those types of loans is somewhere

between 40% and 3500%.

We will later on also cover some of the reasons for those high rates, but now you might be

wondering, why would someone borrow money for such huge interest rates in the first

place?

The general idea is actually that only people, who cannot get a loan from a bank and need

to cover urgent bills, are applying for a payday loan.

This is likely true in many countries but we wanted to find out more which is why we

reached out to the Robocash Group to gather some more accurate information.

The lender was happy to share with us some additional data which is kind of hard to obtain.

Or at least many lending companies are not as keen to share it.

So on this chart, you can see all the reasons why people take payday loans from Robocash

in Russia.

Most borrowers use the money to cover unexpected expenses but also many use it to cover house

renovation or car payments.

Around 12% use payday loans to cover general purchases or medical expenses.

A bit more than 5% use it to buy gifts, pay for bills or cover the gap until the next

income.

And roughly 4% use it to cover education expenses.

As you can see most of the reasons are time-sensitive matters.

You should know, however, that this can also vary depending on the market.

So for instance in Asia, the main reasons why people take payday loans are to cover

education and medical expenses, household appliances and electronics, or even business

expenses.

The fact is that payday loan companies are targeting underbanked borrowers or to put

it simply, people who don’t get access to the bank loan.

It’s just a very different segment of borrowers often in many developing countries where the

regulation isn’t as strict with alternative lenders.

So now you might be thinking.

Great so I am lending money for people who are not able to get a loan from the bank.

Chances that they won’t repay the loan are quite high then right?

Well, it’s not as straightforward and it comes down to the lending practices of the

lenders, their recovery, and default rates.

Now you might be wondering, what are the default rates of individual lenders?

Well, you can reach out to them and ask.

Instead of showing you some made-up numbers from irrelevant payday loan companies, here

is some actual data that we were able to get from Robocash.

On this chart, you can see the default rates from five different lenders in various markets.

You should keep in mind that all of them operate in the payday loan business.

So basically, out of a €100 loan for 20 days, 8€ will be lost for lenders in Russia

and Kazakhstan.

Now that we are aware of the default rates, we need to annualize them.

As we know that Robocash’s average loan term is 20 days, we can easily calculate the

annualized default rates.

Since there are eighteen 20 day periods in one year, we can multiply the default rates

by 18 to get the annualized default rate.

So if our logic is right, these are annualized default rates as you can see on this chart.

So why is this relevant?

Well since the APR represents the annual percentage rate we need to annualize the costs for the

loan to be able to better understand the price of payday loans.

Ok, but let’s hold on for a second.

What the heck is APR actually?

According to Investopedia the APR is expressed as a percentage that represents the actual

yearly cost of funds over the term of a loan or income earned on an investment.

This includes any fees or additional costs associated with the transaction.

What’s also worth mentioning is that not all lenders calculate fees into their APRs.

To streamline this metric, we can use the effective APR, which is sometimes well represented

on Mintos.

That’s actually quite interesting as you could in theory at least get an idea about

the maximum interest range that is being charged to the borrowers.

The only problem here is that it’s not always accurate.

So for instance here, the APR shows the maximum rate of 950% whereas you will be able to find

loans from Sun Finance on the primary market with a borrower APR of up to 3500%.

Anyway, the takeaway here is that now you know that APR could be used as a metric that

will give you an idea of how much a loan cost for the borrowers.

So, now you know that there is likely a correlation between the APR and the default rates.

If the APR is high, it represents a higher risk which equals a higher default rate that

needs to be covered by the APR so the lender and you as the investor can make money.

Now, the defaults are not the only cost factor that needs to be covered by the APR.

Let’s have a look at what other costs need to be covered by payday loan providers.

So we got the APR from which we need to subtract the defaults.

In addition to that, every lender has some operational costs.

Every lending company has some legal expenses as well as costs for the development of their

IT systems.

You should know that most companies offer borrowers to borrow money online which means

that they need to have a solid IT infrastructure supporting their business.

A company also needs to hire employees, so you should, therefore, count on recruitment

costs and payroll.

Every lender has some headquarters for which the company usually pays rent and buys equipment

for their employees.

A big cost factor is also marketing.

Especially if a company is launching a new product in a new market, the cost of marketing

is often enormous.

Many lending companies offer a buyback guarantee so they need to have some reserves in order

to fulfill their obligations towards P2P investors.

In most cases, the lender also needs to pay a fee to the marketplace on which the company

lists loans and from where they get their funding.

And since lenders are for-profit companies, you also need to account for the margin of

the company so it can further grow.

So, after all the costs and profit, you as a P2P investor will get anywhere between 8%

and 16% interest per year.

Now you might think that the companies are making enormous profits.

Well, you can check it by yourself by reviewing their financial reports.

So for instance, the Robocash group which is a large finance group in the PDL business,

made 129.8 M USD in revenue last year.

Out of that 23.8 M USD is profit.

That’s around 18%, which is great, especially considering the turbulent changes in the market

last year.

In most cases, smaller lending companies that just recently launched in developing countries

don’t make any profits within the first one or two years.

There are also a lot of risks that lending companies are taking.

The regulation in many markets is getting tighter which means that regulators are often

capping the interest rates and lenders aren’t able to charge more than the maximum APR which

is determined by the regulators.

Sure, some lenders try to operate on the edge of the law and charge fees for loan extension

and other additional services, at the end of the day, however, this is not a very sustainable

way of operating in the market in the long-run.

So personally, what I like to do is to learn about individual lenders and their lending

practices.

Knowing their track record and how much they rely on P2P investors are factors that help

me decide in which lenders to invest higher investment amounts.

So now, let’s wrap up this video with some pros and cons.

So the benefit of payday loans is obviously the fast payout.

Many companies will lend you money instantly and you will get the money to your bank account

the same or the next day.

This helps you to cover urgent bills and unplanned expenses.

It’s easy and you don’t need to provide as many details.

You can literally borrow money online within a few minutes.

So the disadvantages of payday loans are obviously the enormous cost for the borrowers.

Typically the loans get repaid with the next paycheck otherwise the chances of falling

into a debt spiral are quite high.

Also, some lenders charge extraordinarily high fees which aren’t really justifiable.

So, at the end of the day, if there is a demand for such a product, there will always be someone

to fill this gap in the market and offer a solution to solve this credit gap.

Whether it’s morally correct to support the lenders by investing in them is up to

you to decide.

If you have a problem with it you can invest in real estate backed loans instead which

are structured in a different way so you can even help create new jobs or help build homes

for people who will eventually live in them.

So, the added value for society is certainly higher as when funding payday loans.

A big difference between those types of loans is, however, often the liquidity and return.

Since payday loans have a loan term of less than a month, you can easily access your capital

within a few days, should you need to withdraw your money.

In addition to that, you often get slightly higher interest rates for payday loans as

opposed to real estate-backed loans.

The reason for this is obviously the higher risk.

You as an investor should decide what’s the better fit for you.

Perhaps you want to balance those two loan types to get the benefits from both worlds.

That’s actually also our recommended diversification strategy.

If you want to diversify your P2P portfolio, diversifying across two loan types is a much

better option than spreading it across ten P2P platforms.

So that’s been an extensive video about payday loans.

I hope you found it helpful and informative.

It’s been one of the most research-intensive videos on this channel, so if you appreciate

the value from it, leave a like and comment below whether you prefer to invest in payday

loans or in real estate-backed loans.

So that’s it from me today, thanks for watching and I will catch you in the next video.