Zopa update: Interest rates rise for savers, but bad debt doesn’t

Back in March 2008, I asked if rising interest rates at Zopa, the British peer-to-peer lender, were an opportunity for cash-rich savers or an accident waiting to happen:

In the A*, 24-month market, I seem to be in the zone with an interest rate of 10.5%, which Zopa estimates will give me 9.5% after bad debt.

That 9.5% is almost 50% more interest than on the best savings accounts available from banks at the moment.

I’m gob-smacked.

My post generated a few comments around the web. Even Zopa joined the discussion on the Zopa blog:

Johnnie Moore pointed us towards Monevator and a recent post about Zopa, and we thought it contained some food for thought. […]

Our default rate remains at less than 0.1% and we’ve seen no evidence of increasing bad debt. With our state-of-the-art credit and affordability checks, we’re confident that our credit process will continue to perform well.

So, sit back, relax and have a really nice relaxing biscuit and tea filled weekend!

Zopa was right. Nearly 10 months on I’m yet to see any bad debt. I’ve had a few late-payers but so far Zopa’s credit control has proved impressive and they’ve all coughed up.

Reminder: Zopa is a peer-to-peer lending platform. Rather than saving money in a bank, you effectively become a bank yourself, spreading your money between other Zopa members who are borrowers and who pay you interest. Think eBay for savings.

Zopa was recently on the BBC’s Working Lunch programme. Declan Curry and his team put together this great report on the service:

I’ve also discovered a fellow Zopa user, Paul Bain, who is reporting on his Zopa experiences. Paul’s report reminded me to provide an update here, too.

Here’s my earnings on the £1,000 I’ve trickled in since opening my Zopa account:

Note all the data you get as a Zopa lender. You can go right down to the level of your individual borrowers, and even see what they intend to use the money for!

As you can see I’ve suffered no bad debt – a great result considering we’ve just gone through a credit crisis that sprang from the mismanagement of risk. While major banks have been forced to merge or get bailed out, Zopa has seemed relatively immune.

Interest rates go higher

Zopa’s low default rate has been achieved without reducing the interest rates achieved by lenders. In fact, average interest rates have gone up since I wrote about the service last March.

Zopa says the average interest rate for lenders over the past year has been more than 9%. For my part, I’m now lending new money at 10% or more. The bulk of my money is lent out at around 8%, due to the lower rates prevalent when I began lending, and my favoring three-year terms.

All these interest rates include a 1% fee due to Zopa, so I’ll get 10% on a loan rate of 11%, even if my borrowers make all their payments. But considering the best mainstream deposit accounts here in the UK are paying around 5-6%, I’m pleased to have money earning 8-11%.

Zopa has unique risks as well as rewards

It’s important to realize that Zopa is very different from conventional savings accounts, and accordingly presents very different risks.

With Zopa, you aren’t covered by the Financial Services Compensation Scheme that guarantees up to £50,000 of savers’ money in conventional banks. The FSA Scheme used to seem like a technicality, until UK banks started going bust.

Far more likely than a total wipe-out at Zopa though (especially as the company ring fences members’ money from company money) is a recession that sees more people unable to pay their loans, and so an increase in bad debt.

Zopa’s default rate is still reportedly less than 0.1%. But some lenders on the Zopa discussion boards say they are seeing more late payers:

A few more late payers have shown up in MLB in the last couple of days. My experience so far, however, suggests that while it may be a minority, it’s far from tiny. I’ve had 29 borrowers miss a payment. Of those, only 15 have gotten back on track. Four have defaulted and one is making regular payments under an arrangement, but the payments are so low that they don’t even cover the interest accruing each month so this borrower owes more now than they did when they missed their first payment. That leaves nine that are still in Late, three of which are very recent and six of which are with CRS.

Zopa claims its credit checking is far superior to the banks, and its hitherto low default rate certainly backs that up. But if unemployment hits three million as some predict, a rise in bad debt seems inevitable.

The extra interest rate you achieve at Zopa over a bank account is a partial cushion against rising bad debt, however. And as I only lend to A*, A and B level borrowers (70% of my money is with A* borrowers, who represent the safest credit risk in the Zopa system), I should be somewhat insulated from rising defaults.

Zopa pulled out of the US market after just 10 months, where the authorities last year froze new loans by peer-to-peer rivals such as Prosper, Lending Club and Loanio. But with over £30 million dealt out between 220,000 Zopa members, the business in the UK looks sustainable.

Zopa is not for everyone. It takes more time than running a normal bank account, though that’s partly because it’s 20 times as much fun. Niggles like the ability of borrowers to repay at any time without penalty are more serious, damaging Zopa’s chances of becoming a genuine new asset class.

If the equity markets didn’t look so attractive, I’d probably put more money into Zopa – its high interest and low default rate has outperformed my expectations.

I’ll continue to periodically report on my Zopa experience, so do subscribe to this blog (it’s free) to catch my future updates.