What Are Secondary Markets in P2P Lending? Why Should You Use Them?

February 2nd, 2021
5 minutes read

When you use a platform like Mintos to invest in a p2p loan, that’s the primary market. But that’s not the only way you can invest in a loan. There’s also the secondary market.

Secondary markets in peer-to-peer lending are marketplaces that allow you to buy and sell already funded loans after the repayment period has begun. Lenders use it to exit loans early. Investors use it to earn a higher return by re-selling or to start lending instantly instead of waiting for new loans to be available for funding.

If you are looking to get out of a p2p loan and do not want to wait for the loan to term out, your primary option is to use a peer-to-peer secondary market. It’s important to know that not all platforms offer secondary markets for loans.  Always make sure to check what features the platform offers before you start investing – particularly if you know you might need to exit the loan early.

One alternative to the p2p secondary market is that some platforms offer lenders the option of selling the loan back to the platform company at a discount (usually between 0-5%). Most newer platforms do not have any options for exiting the investment early.

Fees on the Secondary Market

Some P2P platforms charge a percentage fee of the loan to sell or buy the notes on their secondary marketplace. Most secondary markets charge fees to the seller, and a growing number of marketplaces do not charge anything such as Mintos.

Typical fees for buying and selling are between 0.25% and 1%, but the fee can exceed 1% at some platforms. Always check the exact costs on your p2p platform. You can find the costs on the fee structure page where you see ‘Secondary Market Fees’ or ‘Exit Fees’.

When considering trading on secondary markets, it is essential to consider how often you will trade or need to exit early. This will give you an idea of the profitability of using the secondary market or early exit option. A price of 1% of the outstanding principal will easily take a massive cut out of your profits. But even though platforms might not charge fees directly, only considering the secondary market fees may not cover the total costs of using the P2P lending platform. It might have low selling fees but higher overall costs.

Selling and Buying Loans with a Premium or a Discount

Most platforms allow you to set the price when selling the outstanding loan or part of it.

Experts often describe the “price” of the loan as the outstanding loan balance plus/minus a premium/discount. You might be able to sell it for more or less than the outstanding debt.

An example could be the following. You are interested in selling one of your outstanding loans worth €1,000, giving you the following possibilities:

  • You could try to sell the loan for €1,000 and get your money back.
  • You could try to sell the loan with a premium of, e.g. 2%, resulting in a total price of €1,020 and a €20 profit minus fees.
  • You could try to sell the loan fast by giving a discount of, e.g. 2%, resulting in a price of €980 and a €20 loss plus fees.

Platforms allowing premiums and discounts on their secondary market often put a cap on the maximum and minimum percentage where you can sell and buy loans. The most common limit is 3%.

Why Buy Loans with a Premium or a Discount?

At first glance, it might seem incomprehensible why anybody would want to buy or sell loans with up to a 3% premium or discount. However, there can be good reasons to do so. Some of these are listed below.

Reasons to Buy a P2P Loan for a Premium

  • You want to lend money faster than the time it takes for new projects to get listed and funded. There are often a lot more options on the secondary market than on the market for new loans. Also, new loans may take days or weeks to be fully funded, but loans on the secondary market are ready for investment now.
  • You want to diversify your risk quickly because you know that diversification is key in P2P lending. This is possible on the secondary market where you have instant access to loans backed by different assets, currencies, countries and loan durations.
  • You avoid the highest risk when investing in p2p loans on the secondary market, the early payment default. An early payment default is when a borrower defaults on a loan within the first six months. When you buy a loan with months of payment history, you are buying at a lower risk of default. You avoid the fraudulent borrower as defaults after more than a year are often due to real financial problems, not fraud.
  • You can see a history of repayments and positive development for the borrower. This might justify a higher price because of lower risk.
  • The macroeconomics have changed for the better. A change in the macroeconomics could mean that the interest rates available on the primary market are lower than what you would get by buying loans on the secondary market with a premium.

Reasons to Sell a P2P Loan at a Discount

  • You want to exit a loan quickly and cannot wait for the loan to term out in, e.g. three years. This situation could happen for various reasons. For example, the situation for the platform or the borrower might have changed. Alternative investments could be better choices, or the lender could simply need cash for personal reasons.
  • The situation with the borrower has changed for the worse, resulting in higher risks for potential buyers. Doubts about repayment will cause the market to set a lower price for the loan.
  • The situation with the platform has changed for the worse, resulting in higher risks for potential buyers.
  • The macroeconomics have changed for the worse. Changes in the macroeconomics might result in fewer investors, lower liquidity, which could force investors wanting to exit early to sell at a discount.

Conclusion

The secondary market is a great place to enhance your peer to peer investment returns. You can use it to put money to work right away or increase your liquidity. You get the advantage of seeing payment histories and avoiding early payment defaults. The secondary market is a tool you should add to your investment toolbox if your p2p lending platforms offer them.