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The APR (annual percentage rate) is a comprehensive measure of the cost of a loan, expressed as a yearly rate. It includes not only the interest rate but also any fees charged by the platform, such as origination fees or service fees. This makes it a more accurate measure of the cost of a loan than the interest rate alone. In some jurisdictions, lenders are required by law to disclose the APR to borrowers. For example, if a P2P platform charges a 2% origination fee on a ₹1,00,000 loan with a 12% annual interest rate, the APR would be higher than 12% because it takes into account both the interest and the fee.
Auto-invest is a feature offered by many P2P lending platforms that allow lenders to automate reinvestments based on predefined criteria. In India,if the investor opts, the matured funds can be automatically reinvested into the same investment plan initially chosen.
P2P lending platforms offer borrowers, who may be individuals or businesses, access to funding they might not have been able to secure through traditional channels. Borrowers might choose P2P lending because they don’t qualify for a traditional loan due to their credit history or income requirements or because they can potentially obtain a better interest rate than a bank would offer.
P2P platforms categories each borrower based on their assessed risk of default. This assessment typically takes into account the borrower’s credit score, income, employment status, loan amount, loan term, and other relevant information.
For example, on a P2P platform, a loan from a borrower with a high income and a good credit score might be assigned a low-risk grade and an interest rate of 10% p.a., while a loan from a borrower with a lower income and a poor credit score might be assigned a high-risk grade and an interest rate of 20% p.a. Lenders can use these grades to help decide which loans to invest in, based on their own risk appetite and return expectations.
Colending refers to a partnership between multiple lenders, such as banks and non-banking financial companies (NBFCs), to jointly finance a loan to a borrower. This approach allows the risk to be shared among the lending institutions, thereby promoting greater lending efficiency and reach to different segments of borrowers. Example: A small business may receive a loan where 60% is funded by a traditional bank and 40% by an NBFC, sharing both risk and reward.
A credit score is a numerical representation of an individual’s creditworthiness, based on their credit history and financial behavior. Scores generally range from 300 to 900, with higher scores indicating better creditworthiness. Credit scores are used by lenders to assess the risk of lending to a particular individual and to determine interest rates and credit limits. Example: A credit score of 750 or above is often considered good and may result in more favorable loan terms.
Credit history is a record of an individual’s past borrowing and repayment activities, including information about loans, credit cards, payment punctuality, and any defaults or bankruptcies. It’s a key factor in determining a person’s credit score and is used by lenders to assess the risk of extending credit. Example: A credit history showing timely payments on all debts will typically lead to a higher credit score.
Collateral refers to an asset that a borrower offers to a lender as security for a loan. If the borrower fails to repay the loan, the lender has the right to seize the collateral and sell it to recover the funds. Collateral may include property, vehicles, stocks, or other valuable assets. Example: In a mortgage loan, the home itself serves as collateral for the loan.
Compounding is the process of earning interest on both the principal amount and the previously earned interest. It can refer to the compounding of investments, savings, or loans, and can significantly affect the value over time. Compounding can be on a daily, monthly, quarterly, or annual basis. Example: If $1,000 is invested at a 5% annual interest rate compounded annually, it will grow to $1,050 after one year, and to $1,102.50 after two years, as the second year’s interest is calculated on $1,050.
A CA (Chartered Accountant) Certificate is a document issued by a Chartered Accountant, who is a professional in accounting and finance. The certificate may authenticate various financial statements, income proofs, or other financial documents. In the context of banking and loans, a CA Certificate might be required to verify the income or financial standing of a borrower. Example: A self-employed individual applying for a home loan may need to submit a CA Certificate as proof of income, duly signed by a registered Chartered Accountant.
A default in P2P lending occurs when a borrower fails to make their scheduled loan repayments. Defaults represent a risk to lenders, as they might result in the loss of the invested principal and unpaid interest. The risk of default is inherent in lending and may typically be higher in P2P lending compared to traditional banking due to the nature of the borrowers that P2P platforms cater to.
The platform typically has procedures in place to manage defaults, which can include late payment fees, debt collection efforts, and legal action. However, these measures do not guarantee the recovery of the outstanding debt. In India, the Reserve Bank of India (RBI) has regulations in place that require P2P platforms to have measures for recovering defaulted loans, but they cannot guarantee repayment of loans to lenders.
Diversification is a risk management strategy that involves spreading investments across a wide variety of loans to reduce exposure to any single borrower. This is particularly relevant in P2P lending, where the risk of default can be relatively high. By investing small amounts in a large number of loans, lenders can mitigate the potential impact of any single loan defaulting. Many P2P platforms facilitate diversification by allowing lenders to invest in fractions of loans, which are smaller portions of a larger loan.
This is when a borrower pays back their loan before the end of the term. Depending on the platform’s policy, borrowers may be able to repay their loan early without any penalties, or there may be fees for early repayment. Early repayment can reduce the amount of interest a borrower pays, but for the lender, it can mean a lower-than-expected return.
Escrow is a financial arrangement where a third party holds and regulates the payment of funds, ensuring that transactions are conducted according to the agreed terms. It is commonly used in real estate to protect the interests of both the buyer and the seller before a sale is finalized. Example: A homebuyer might place the down payment in an escrow account, to be transferred to the seller only after the property’s title is clear of any disputes.
FLDG is a risk-mitigation tool commonly used in structured finance transactions. It’s a guarantee that covers the first portion of losses up to a specified amount or percentage, in case of defaults. This helps in enhancing the creditworthiness of a debt instrument and can lead to better credit ratings. The FLDG is often provided by the originator or an external entity to make the associated financial product more attractive to investors by limiting their initial risk exposure. For instance, in the securitization of a loan portfolio, a bank might provide a 10% FLDG, meaning the bank would absorb the first 10% of losses from defaults before other investors are affected.
As of 2023, under the new guidelines by RBI for Fintechs, a default cover can be extended to a maximum of 5% of the loan portfolio and must be activated within an overdue period not exceeding 120 days.
FOIR (Fixed obligations to income ratio) is a parameter used by Indian financial institutions to assess a loan applicant’s eligibility. It represents the proportion of a borrower’s income that goes towards servicing existing fixed obligations, such as other loans and recurring liabilities. Generally, if the FOIR is too high, lenders may view the borrower as a higher risk.
In the context of P2P lending, interest is the cost of borrowing money, paid by the borrower to the lender. It’s typically expressed as a yearly percentage of the principal, known as the interest rate. For example, if a borrower takes a loan of ₹1,00,000 at an interest rate of 12% per annum, they will owe ₹12,000 in interest over one year, in addition to repaying the principal. The interest compensates the lender for the risk and the opportunity cost of lending their money. In P2P lending, interest rates can be determined by the platform or through a bidding process where lenders offer the rates at which they’re willing to lend.
In P2P lending, a late payment occurs when a borrower does not make the scheduled repayment by the due date. Different platforms have different policies for dealing with late payments. Some may charge a late fee, others may initiate a debt collection process. Late payments can negatively impact a borrower’s credit score and can increase the risk for the lender.
On the other side, lenders or investors looking to earn higher returns than traditional saving methods can invest with P2P platforms to earn a return on their funds. These are typically individual investors but can also include institutional investors. Each investor can fund a fraction of a loan or fund multiple loans to diversify their investment and mitigate risk. The rate of return on these investments corresponds to the borrower’s interest payments on their loan.
A loan agreement is a formal contract between a borrower and a lender which details the terms and conditions under which the borrower agrees to repay the amount borrowed. It outlines interest rates, repayment schedules, default penalties, and other essential terms. Example: Before receiving a mortgage, a homebuyer signs a loan agreement ensuring they understand the repayment terms and their responsibilities.
The LTV ratio is a measure used in secured lending, including some P2P loans, to assess risk. It is calculated by dividing the loan amount by the value of the collateral. For instance, if a property worth ₹1,00,000 is used as collateral for a loan of ₹70,000, the LTV ratio is 70%. The lower the LTV, the lower the risk for the lender, as there’s a better chance of recovering the investment if the borrower defaults.
The leverage ratio is a financial metric that measures the relationship between a company’s debt and its equity or assets. It is used to evaluate a company’s financial risk, specifically its ability to meet its debt obligations using its assets or equity. A higher leverage ratio indicates a higher level of debt relative to equity, suggesting increased risk. Conversely, a lower leverage ratio indicates a lower level of debt, which generally means reduced financial risk.
For example, a ratio of 2 means that for every rupee of equity, the company has two rupees in debt, indicating a relatively high level of financial risk. If Company A were to face financial difficulties, it might struggle to meet its debt obligations, which could lead to bankruptcy or other adverse outcomes.
A high leverage ratio may signal high financial risk but can also lead to higher returns during good times. A low leverage ratio generally indicates lower financial risk but might also mean that the company is not taking advantage of financial leverage to boost potential returns.
A merchant loan in India refers to financing provided to merchants or retailers, often based on their daily or monthly card sales. Lenders assess a merchant’s eligibility for a loan based on their card transaction history. These loans are typically short-term and are designed to help merchants manage their working capital needs.
NPAs (Non performing assets) are loans or advances for which the principal or interest payment has remained overdue for a period of 90 days or more. An asset becomes non-performing when it ceases to generate income for the bank or financial institution. High levels of NPAs can indicate financial distress in the banking sector and are closely monitored by the Reserve Bank of India (RBI).
An NBFC (Non-banking financial company) is a company registered under the Companies Act of India, engaged in the business of loans and advances, acquisition of shares, leasing, hire-purchase, insurance, or chit-fund business. Unlike banks, NBFCs cannot accept demand deposits and do not form part of the payment and settlement system. They are, however, an essential part of the Indian financial system, complementing the banking sector by serving unbanked regions or sectors.
NBFC-P2P refers to a special category of NBFCs that operate online platforms to bridge individual borrowers and lenders, facilitating peer-to-peer lending without any traditional financial intermediaries. The Reserve Bank of India regulates this lending model, setting guidelines on fund transfers, maximum limits on lending and borrowing, and operational requirements to protect consumer interests.
This is a fee charged by some P2P platforms to cover the cost of processing a new loan. It is usually deducted from the loan amount before the funds are transferred to the borrower. For instance, a 2% origination fee on a ₹1,00,000 loan would mean the borrower receives ₹98,000.
P2P (Peer-to-Peer) lending, also known as social lending or crowdlending, is an alternative financing system that enables individuals to borrow and lend money directly through an online platform without the involvement of a traditional financial intermediary like a bank or a credit union.
The P2P platform acts as a marketplace that brings together borrowers and lenders. They are responsible for facilitating transactions, assessing the creditworthiness of borrowers, setting interest rates, and often collecting repayments from borrowers and distributing them to lenders. They make money by charging fees, which could include origination fees from borrowers and service fees from investors. In India, popular P2P lending platforms include Faircent, Lendbocx, LenDenClub, and Liquiloans.
A personal loan is a type of unsecured loan that individuals can apply for from a bank or financial institution. It’s generally used to finance personal expenses such as home improvements, medical bills, or a vacation. Unlike secured loans, such as mortgages or car loans, a personal loan does not require any collateral. Approval and interest rates for personal loans are typically based on the borrower’s credit score, income, and other financial factors. Repayment terms vary but usually include monthly payments over a set period, often ranging from 1 to 7 years.
The principal is the original sum of money lent to a borrower by a lender. The principal does not include interest. For example, if a lender decides to lend ₹1,00,000 to a borrower via a P2P platform, ₹1,00,000 is the principal. The borrower is obligated to pay back this amount over the term of the loan. In P2P lending, investors often distribute their principal over several different loans in order to diversify their portfolio and mitigate risk.
This is the predetermined plan for paying back a loan. It outlines when repayments are due and how much each repayment will be. In P2P lending, the platform usually determines the repayment schedule, which can be monthly, quarterly etc., depending on the terms of the loan.
This denote the gain or loss made on an investment over a particular period. It is expressed as a percentage of the investment’s initial cost. Returns can be derived from various sources, such as stock appreciation, dividends, interest from bonds, or rental income from real estate. For instance, if you invested ₹10,000 in a mutual fund and its value increased to ₹11,000 after one year, your return would be 10%.
A secured loan is a loan that is backed by an asset or collateral. If the borrower defaults on the loan, the lender has the right to seize the collateral to recover their investment. This collateral could be a property, a vehicle, or other valuable assets. In the context of P2P lending, secured loans are relatively rare, but some platforms do offer them. These loans are generally considered to be less risky for the lender, as they have a means of recouping their money in case of default.
Some P2P platforms have a secondary market where lenders can sell their liquid investments as well as investments before the end of the loan term. This provides a way for lenders to liquidate their investments if they need to.
A subvention scheme refers to a kind of home loan where the developer pays the pre-EMIs (Equated Monthly Installments) on behalf of the buyer for a certain period or until possession. These schemes are designed to reduce the financial burden on buyers who might be paying rent alongside EMIs. The term ‘subvention’ essentially means a grant or subsidy.
The term of a loan refers to the length of time that the borrower has to repay the loan. In P2P lending, the term can vary significantly, ranging from a few months to several years, depending on the platform and the specific loan. The term of the loan can affect both the risk and the potential return for the lender. Longer-term loans may offer a higher return, but they also carry a higher risk, as there’s more time for the borrower’s circumstances to change and potentially lead to default.
Underwriting is the process of evaluating the risk of lending to a particular borrower. It involves assessing the borrower’s creditworthiness and ability to repay the loan. In P2P lending, the platform usually performs the underwriting, using data such as credit scores, income, and employment history. The result of this process is often reflected in the risk grade assigned to each loan.
An unsecured loan, on the other hand, is a loan that is not backed by any collateral. The majority of loans on P2P platforms are unsecured, which means that if a borrower defaults, there’s no specific asset that can be seized by the lender to recover their money. The lender would have to go through the debt collection process or legal proceedings to attempt to recover their funds. Because of this additional risk, unsecured loans usually carry a higher interest rate than secured loans.
XIRR (Extended internal rate of return) is a financial function used to calculate an annualized rate of return for investments that may not be periodic. It is particularly useful in the context of the Indian market for evaluating the returns of investments like mutual funds, where one might invest at irregular intervals. For instance, if you make lump sum and systematic investment plan (SIP) contributions to a mutual fund, XIRR can give you a more accurate picture of your overall annualized return.
Yield refers to the income return on an investment and is typically expressed as an annual percentage based on the investment’s cost or its current market value. Yield is commonly discussed concerning bonds, where it denotes the interest earned relative to the bond’s price. For instance, if a ₹1,000 bond offers ₹80 as annual interest, its yield would be 8%. Yield is also a significant indicator for other financial instruments like stocks (dividend yield) or real estate (rental yield).