Simple Pound

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A year ago I wrote about Zopa, a (then) new loan concept that wanted to bring people together in order to facilitate a lending and borrowing market that wouldn’t require banks. The concept is remarkably easy - on the one hand we have people with spare cash looking for a good and (reasonably) safe return while at the same time we have people out there who are looking for some spare cash (i.e. a loan). Why not make these people talk directly, instead of forcing the former group to deposit their savings into a bank account with a mediocre interest rate and subject the latter to bank’s exorbitant fees (exceptions apply)?

After I had been watching the Zopa site grow for quite some time, I decided that it was time to join the fun and have a go at it myself. With the house purchase one of my major short-term goals at the minute, I didn’t want to tie up a lot of capital for a long time, hence the amounts I’m allowing myself to use at Zopa are fairly small (£ 25 in total at the minute, increasing by about £ 10 a month). Nevertheless I figured I had seen enough to share my experience with the site so far…

Signing up: Ideally this should have been a fairly easy process, especially since I was intending to become a lender, not borrower. However, due to money laundering regulations Zopa is still required to verify your identity and address. Since we’ve moved to our current flat only a few months ago, this identity check could not be carried out online and I had to submit the usual proof of identity and address documentation. This is nothing unique to Zopa and I’ve encountered the same issue several times before with banks, credit card and loan companies. In the end it took only 2 days for them to process my documents and I could sign up successfully! Overall impression: good.

Customer Service: Apart from the registering process I’ve had several other encounters with the Customer Service department relating simple queries as well as a functionality problem at one point. The usual way of contacting them is by sending an email and the response time is always within the promised 1 - 2 business days. All requests were dealt with swiftly and the team is very helpful and always friendly. Overall impression: excellent.

Transferring money: There are three major ways you can transfer money into your Zopa account: Debit card by phone (for instant transferral) or online (for transferral within the same business day), standing order (similar to the way you’d set up the standing order for a savings account) or by bank transfer (longest of all methods as it takes about 3 days to reach your account). With either option you will receive a confirmation email when your funds reach the account and are ready to be used. To transfer money out, you will need to have your bank account confirmed with Zopa. To do that, you simply need to transfer £1 by bank transfer once for them to be able to verify the account belongs to you. At this stage, you cannot transfer the money in your Zopa account to anybody else but yourself. Overall impression: very good.

Lending in Zopa Markets: With Zopa you have two major lending options - Markets
or Listings. If you allocate your money to the Markets section, most of the work matching your lending offer with a borrower request will be done behind the scenes for you. You merely see your money moving between the stages of being offered (currently available), processing (matched to a borrower, loan verification in progress), lent out and late payments (hopefully very few in the latter category). To determine your rate of return you can either give Zopa your desired rate of return and the longest amount of time you’re willing to tie up your capital or you can fine tune your offer by indicating an exact rate of return per market segment. These segments are determined by the borrowers credit rating and the duration of the loan and range from A* for 12 months to C for 60 months. Zopa is helping you to offer realistic rates by quoting you a range of rates that other lenders are offering.

My experience with the Markets section is thoroughly positive. I’ve got all my lending offers at the higher end of the market range and yet I find that my available money is usually processing within a time span of about 2 days. I’ve only had one slight hiccup so far that was explained to me and hence resolved by the Customer Service team within 2 days (my Zopa account contained a little less than the shown £ 10 due to the Zopa fees being earmarked but not deducted every month). Overall impression: good

Lending on Zopa Listings: Zopa Listings are essentially an eBay-like reverse auction system where borrowers advertise their borrowing needs together with an explanation of their finances and lenders can quote how much they’d be willing to lend to this one borrower and at which rate. All quotes get aggregated throughout the duration of the listing. When the borrower’s desired loan amount has been reached (i.e. funding is at 100%), lenders can continue to quote and hence will start outbidding each other with lower rates. Eventually only the minimum number of lenders with the lowest rates will be kept in the listing and hence will be able to lend their money to the borrower. The advantage of the Listings is that you might be able to get a higher rate than you’ve quoted in the Markets section by bidding at the last minute - similarly to how you can get a bargain at eBay through sniping (or old-fashioned pressing of refresh and bidding on the last second).

I’ve only (actively) participated in one Listing so far which ended at 4.20am in the morning. I waited to submit my quote until half past midnight and went to bed hoping lots of people would have already done the same. By the time I submitted my quote, I was about 50 offers (out of 130) away from being excluded so I felt pretty safe and happy as I had a good impression of the borrower. Unfortunately I was out-bid just 15 minutes before the end of the Listing… In any case, the entire process was certainly exciting and I’m intending to look out for other Listings as soon as I fund my Zopa account with more money (waiting for the paycheck, anyone?). Overall impression: excellent

Total verdict: For me, Zopa turned out to be everything I expected and wanted it to be. Obviously I can’t really comment on the bad loan rate at this stage, but then I don’t think it is a major part of evaluating Zopa itself. Every lender can adjust the risk he or she is willing to take by only offering money in certain (high-quality) markets or reducing the term of the loan they’re happy to accept. I believe that people might be less likely to default on their loans when they know that they owe their money to individual people, not big face-less institutions - if you had the choice, whom would you pay back first? Your neighbour or the bank? I might be wrong, but this is what I would like to believe and Zopa’s low bad-loan quota might prove just that.

If you’re intrigued by the concept and would like to explore alternative ways of making money / earning a return on investments, I urge you to give this a go. Sign up here to get £30 when you start lending (minimum amount applies) and become part of the Zopa Community. Trust me, it’s fun!

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Having read yesterday’s post, you should now know what bonds are and that their price can differ from their par (face) value depending on various (mysterious) external circumstances. You have also read that after you’ve bought a bond its price only really concerns you if you’re planning to get rid of it before the maturity date. That’s a major difference to shares, whose price determines the value of your investment. With a bond on the other hand you can be certain that you will always get the bond’s par value back (assuming the issuer doesn’t default) plus any interest that might be payable ‘along the way’. This is the major reason why bonds should only constitute a small percentage of your portfolio while you’re young (i.e. you should make the most of your money rather than sit on a close-to risk-free bond)…

So what is it that influences the price you can sell your bond for?

• Interest rates: Rising interest rates mean you could potentially get a higher return even if your money is only sitting in a savings account. Therefore, bonds that issue after a rise in interest rates will offer a higher annual return (yield) in order to keep up with your savings account (and thus your bank!). This also means, the price for existing bonds might drop because their yield has now become less competitive and thus investors are willing to pay less. The only way to ‘convince’ investors to buy a bond with a low coupon rate, is by offering it at a discount. The same logic applies when interest rates drop - already issued bonds become more attractive and demand can only be limited via an increase in price.

• Inflation: When inflation increases, bond prices will decrease because the coupon rate might not be high enough to keep up with inflation. Especially with bonds that have a long maturity you will often find higher coupon rates to keep the bond attractive even if inflation might change substantially over the long run.
• Financial health of issuer: If the market believes that there is almost no risk of the issuer defaulting, the bond’s price will increase to reflect a high-quality security. On the other hand, if the investor is in some financial difficulties, not many people will be willing to accept the associated risk and the price will drop.

If you are keen to find out more about bonds (there is so much more material out there, trust me), I suggest you start here. There are many varieties of bonds available plus the option of investing in bond funds - i.e. a collection of bonds administered by someone who (hopefully) knows what they’re doing. The concepts are fairly similar to mutual funds so I will only cover them briefly next time.

Read part 7 of “Investment Choices” on bond funds >>

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All of the investment choices covered so far concern equity securities where the investor, after buying shares in one form or the other, owns part of a company. Debt securities constitute an alternative way for corporations (or governments!) of raising finance - without having to give up part of their company.

When you buy a bond you essentially make a loan to the corporation, the government or whoever else the bond’s issuer might be. Just like when you take out a loan with your bank, the issuer of the bond has to pay interest for being allowed to use your money.

Bonds are determined by three components: the par (or face) value, the coupon rate and the maturity. If an issuer wants to borrow £20,000 for 5 years and is willing to pay 7% interest on this money, the available bond will have a par value of £20,000, a coupon rate of 7% and a maturity of 5 years.

Issuers who want to keep the option of paying back back the face value before maturity, issue a callable bond, while issuers who don’t want to pay interest annually (or quarterly, monthly…) can create a zero-coupon bond. With this type of bond, no interest payments are being made during the loan period but the cumulated interest is paid together with the par value of the bond upon maturity. The advantage of the latter is that these bonds are usually priced at a discount to balance out the fact that no (interim) interest payments are made. This means, to buy a £1,000 bond you might only have to provide funds of £900, but the cumulative interest that you will receive upon maturity is based on the bond’s par value.

The coupon rate of the bond is mainly influenced by the current interest rate, the length of the term and the creditworthiness of the issuer. A company that has a relatively high risk of defaulting (i.e. not being able to pay back the loan) will have to pay higher coupon rates to balance this risk.

Because all of the above determinants can change after a bond is issued, the market value of a bond can and will vary over time. This variation is expressed as a percentage of the par value (i.e. 95% or 102%). Close to maturity, when interest rates and creditworthiness of the issuer won’t have sufficient time to adjust, the bond’s price will converge to 100% par value.

The good news is: if you buy a bond and plan to hold it until it matures, none of the above does affect you in any way. It just gets interesting once you’re trying to sell the bond on the secondary market (i.e. sell the right to receive interest payments from the issuer to some other investor).

More about the factors influencing bond prices soon (in case you don’t intend to hold on to the same bond for 20 years…).

Read part 6 of “Investment Choices” for more on bonds >>

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