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.