When a borrower takes out a loan, they’re obligated to pay back that loan. If the borrower doesn’t pay back that loan when a payment is due, the loan is considered in default. This means the loan has not been paid based on the agreed-upon terms.
Defaulting on a loan happens to some borrowers any number of reasons, all which ultimately prevent the borrower from repaying the lender. For the purposes of investments, we’ll look at what happens to defaulting on unsecured and secured loans, as well as what a borrow defaulting means for Percent investors.
Loans in Default: Secured vs. Unsecured Loans
When a loan is in default, the terms of the loan dictate what happens next. If even one payment is missing, the loan terms could dictate a written warning requesting payment, a penalty for defaulting, or the forfeiture of some/all of a borrower’s collateral. Each loan’s terms are unique and differ from loan to loan and lender to lender.
A secured loan has terms that allow for a lender to keep some or all of a borrower’s collateral upon default. Keeping and/or liquidating the collateral gives the lender the ability to recoup some or all of the money lost in the default.
An unsecured loan does not afford the same luxuries. If a borrower defaults on a loan, the lender and often times a loan collector will continue to try and collect the remainder of the loan from the borrower. Depending on the terms and severity of the default, this can lead to legal action as well, until the terms of the loan are met.
How does this apply to Percent investments?
There is always a risk involved with investing, including investments made on Percent. If an underlying borrower does not meet the financial and/or contractual obligations of a loan made by an originator, the risk in this case is defaulting on the loan. This is known as credit and repayment risk.
If an underlying borrower defaults on a loan, it could have an impact on the principal and/or interest paid to a Percent investor. After all, if the money is not paid back to the originator in the case of a default, there is no money to be paid to the investor. However, most Percent offerings include credit enhancements designed to absorb a certain percentage of defaults on the originator’s loan portfolio before Percent investors experience any defaults on their investment.
It’s worth noting that, as of March 2021, only 1.1% of deals on Percent have experienced some level of default in the process. To better understand these risks, be sure to perform your own due diligence on prospective deals before you invest in them, using information like the data contained in Surveillance Reports to learn more about the health of the underlying loans and involved parties.
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