In P2P lending, a buyback guarantee is a contract between the lender and the loan originator, with the purpose of protecting lenders against borrower defaults. The buyback guarantee is provided by the loan originator and the loans for which applies will often be marked with a shield.
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 loan originator is obligated to buy back the loan either fully or partly. Depending on how the buyback guarantee is structured, this will compensate lenders for the remaining principal and some or all of the interest and penalty fees.
Do a Buyback Guarantee Eliminate Risk Completely?
A buyback guarantee do 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” and the loans will have to be handled by someone else or be lost.
An example of a loan originator bankruptcy is Eurocent, who went bankrupt on May 9, 2018. Eurocent was listed 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 best it can for the investors to recover some of the money. The latest financial report of Eurocent can be found here.
In many ways, the buyback guarantee in P2P lending resembles a small system like the risk-free scenario seen in the 2007 financial crisis with the giant AIG insurance company going bankrupt on excessive gearing and the defaults of many sub-prime borrowers. It is therefore necessary to show some caution even when investing in loans with a buyback guarantee.
That being said.. What are the Benefits of a Buyback Guarantee?
The main benefit of a buyback guarantee is a higher certainty of obtaining the cashflow generated 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 the cashflow on a short-term basis. On the other hand, there is a higher risk of an instant drop in cashflow if the loan originator guaranteeing the buyback goes bankrupt.
The buyback guarantee basically connects the default of loans to the company who issues them. A benefit of this might be that it removes some of the incentive structure for the loan originator to accept bad borrowers to earn a quick commission.
On the other hand, the buyback guarantee can also create an illusion of operating in a risk-free environment. The consequence of this might be that the moral hazard is moved from the borrower to the risk of a loan originator indirectly gearing deferred revenues resulting in a scenario similar to what arose with Credit-Default-Swaps (CDS).
In conclusion, 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, there is most likely a better incentive for the loan originator to provide quality loans because 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 guarantees as this means you will only be operating on p2p platforms based on the four-party business model consisting of 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 very different from platform to platform.
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 part involved, where assets are secured transparent legal documents established is probably less risky and more like traditional investing in promissory notes.
Diversification is important in the P2P lending market and although buyback guarantee is often involved with high risk, it can be a good solution with certain loan originators to insure the cashflow. 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 three party platforms without loan originators.
6 Different Buyback Guarantees with Different 'Promise' Structures
Most loan originators at Mintos provides their own Buyback Guarantee with different terms yet usually promises to repurchase the loans if they are delayed more than 60 days with or without penalties and interest income on delayed payments.
The platform itself (Monethera GROUP OÜ, Reg. No.: 14616437) guarantees to buy back the loan at a 5% fee anytime you want/need to exit before the final installment. To further secure the lenders, they guarantee 35% of outstanding principal in their so called Reserve Fund in in case borrowers defaults and will reimburse 35% of the remaining principal instantly while the remaining up to 65% principal will be reimbursed when the case has been through court and collateral realized.
Some of the loan originators at VIAINVEST provides 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 since investment date.
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.
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.
The platform itself (Envestio SI OÜ, Reg. No.: 14433607) offers to buy back loans at any given time instantly as long as there is sufficient funds to execute the buyback immanently. The costs of selling back varies from project to project and its situation and can be found in the project description.