In Peer-to-Peer lending, a buyback guarantee is a contract between the lender and the loan originator. Its purpose is to protect lenders against borrower defaults. The loan originator provides the buyback guarantee. The loans where the buyback applies will often be marked with a shield on a lending platform.
The way the buyback guarantee works is if a borrower misses payments for a certain number of days, usually between 30 to 90 days, the guarantee will take effect. The loan originator must buy back the loan either partly or in full. Depending on how the buyback guarantee is structured, this will compensate lenders for the remaining principal and some or all the interest and penalty fees.
Does a Buyback Guarantee Eliminate Risk Completely?
A buyback guarantee does not eliminate risk, it simply moves it to a more centralized place – the loan originator. If the loan originator goes bankrupt, it will not be able to honor its “guarantee”. Outside servicers would have to handle the loans or the loans could default.
An example of a loan originator bankruptcy is Eurocent, who went bankrupt on May 9, 2018. Eurocent originated loans on Mintos, one of Europe’s biggest P2P lending platforms. The loans listed on Mintos went bad, causing investors to lose both the principal and the interest. Mintos is trying their to allow investors to recover some of the money.
You need to exercise caution even when investing in loans with a buyback guarantee.
So why should you care about Buyback Guarantees when investing in P2P Lending?
The main benefit of a buyback guarantee is a better chance of receiving the cashflow you expect from investing in loans issued by the loan originator. If a loan defaults, you as an investor do not have to wait maybe years for the loan to be paid back or the default claim to settle. Because of this, this type of contract gives better predictability of cashflow on a short-term basis. Yet, there is a higher risk of reduced cashflow if the loan originator guaranteeing the buyback goes bankrupt.
In essence, what you are doing is investing in a higher risk loan based on two pledges:
- the borrower’s pledge to repay to the originator and
- the originator’s buyback guarantee with the platform
and the hope is the extra pledge makes up for the increased risk.
The buyback guarantee basically connects the default of loans to the company who issues them. This removes some of the incentive structure for the loan originator to accept bad borrowers to earn a quick commission.
The benefits of investing in a peer-to-peer loan with a buyback guarantee is that you can better predict the cashflow and interest earned from the portfolio of loans. Also, the loan originator’s incentives match the lenders to provide quality loans. As long as the loan originator is operating it will have to buy back issued loans with missed payments.
Should I Prefer Loans with a Buyback Guarantee?
When investing in P2P lending you should not necessarily only go for loans with a buyback guarantee.
Why? Because this means you will only be operating on p2p platforms based on the four-party business model. This model has:
- a borrower,
- an investor,
- the p2p platform and
- a loan originator.
Compared to the three-party business model that does not involve an independent loan originator, the structure in the four-party business model is more complex and harder to understand – and it will normally be risky for you as an investor to operate on this type of p2p platform. Also, the four-party business model involves considerations such as:
- direct and indirect investment structure and
- the level of Skin in the Game can be different from platform to platform.
The buyback guarantee only exists on peer-to-peer platforms based on the four-party business model. Lending to businesses, real estate or persons directly with only one serious party involved, where assets are secured with transparent legal documents established is less risky and more like traditional investing in promissory notes.
Alternatives to P2P Buyback Guarantee
Diversification is important in the P2P lending market. Although the buyback guarantee is often involved with higher risk, it can be a good solution with certain loan originators to insure the cashflow. Other platforms insure cash flow with provision funds. If you want to bypass the costs with loan originators and its security of the buyback guarantee, it is possible with these high interest non-bank loans on platforms like EstateGuru or other platforms without external loan originators and the buyback guarantee.
In the following are four different buyback guarantees and how they work on the respective p2p lending platforms.
Four Different Types of P2P Buyback Guarantees
- Mintos Buyback Guarantee
Most loan originators at Mintos provide their own Buyback Guarantee with different terms yet usually promise to repurchase the loans if they are delayed more than 60 days with or without penalties and interest income on delayed payments.
- VIAINVEST Buyback Guarantee & Buyback Button
Some of the loan originators at VIAINVEST provide a Buyback Guarantee when loans are delayed 30 days and the platform itself offers a Buyback Button that allows lenders to cancel the investment after 120 days from the investment date.
- IUVO Group Buyback Guarantee
All loan originators at IUVO Group are obligated to buy back the loans without accrued interest if payments are delayed for more than 60 days, counted from the day of the first unpaid installment.
- NEO Finance Buyback & Provision Fund
The platform itself (NEO Finance AB, Reg. No.: 303225546) offers to buy back terminated (some time between 60 to 130 overdue days) loan contracts at 50%-80% of face value and also gives the option for lenders to select the Provision Fund for a fee depending of the creditworthiness of the borrower but always between 0.44% to 22.91%, guaranteeing to buy back defaulted loans if the service is optionally selected.
NB. NEO Finance recently notified that they started using a portion of the Provision Fund to invest into consumer loans.