Here's our helpful alternative finance jargon-buster!
In a nutshell
Learning about new things can require time and effort, however high your IQ may be. Added to that, if you're learning about niche jargon, and specific terms and expressions within the Alternative Finance and Property Crowdfunding sectors, your task may well multiply in size.
For the new investor looking to foray into the world of Property Crowdfunding, the myriad of terms often used on websites and publications are sometimes difficult to understand.
However, all is not lost. What can seem like a tidal wave of inexplicable acronyms and initialisms will be deciphered right on this blog. We aim to help by offering a Jargon-Buster page which will shine some light on the basics of the Alternative Finance lexicon.
A familiar feeling...
When reading magazines, brochures or blogs about finance, they can seem to be a semantic minefield strewn with jargon, acronyms, initialisms and niche lingo that can sometimes turn the reader off, especially if you are new to Alternative Finance. The less you comprehend, the more you skim-read the article thus ignoring key points the writer is trying to get across. You stop engaging, you close the magazine or online window, and something in which you may have been interested is dismissed and forgotten.
Likewise, if you've ever spoken to a Property Developer, or maybe tried to read through a brochure detailing the specifics of a Property Crowdfunding project, the chances are that you will have come across some terms with which you are not familiar.
Though these terms and expressions may not crop up in the everyday lexicon of most people going about their day to day business, they are prevalent within the Alternative Finance sector, and it's a good idea to become accustomed to their meaning.
Although to a certain extent, it is a writer's responsibility to write captivating text, some onus also falls on the reader to understand the specifics.
Our Alternative Finance Jargon-Buster should help newcomers to Property Crowdfunding and other areas of Alternative Finance with a clear and concise explanation of some of that "geekspeak" you may well see, to avoid feeling ostracised by an "Alt-fi in-crowd".
Alternative Finance – What is Alternative Finance?
"The new year is now under way, and it will be a crucial one for the Alternative Finance industry" - from AltFi News (03/01/2017)
Alternative Finance is a recent channel of finance that has become increasingly popular over the past decade since the Financial Crash of 2008. This is because it can democratise lending and borrowing by connecting the two factions whilst removing the intermediary of the traditional banks, which, as a result of the aforementioned Financial Crash, were offering increasingly low interest returns on lending.
Described by Wikipedia as:
"Financial processes and instruments, like Crowdfunding and P2P lending, that have emerged outside the traditional finance system such as regulated banks and capital markets."
Alternative Finance has grown substantially, particularly for small and medium-sized enterprises. The United Kingdom currently leads the way for the Alternative Finance Industry within Europe, as, according to the 5th UK Alternative Finance Industry Report from November 2018, it grew by 35% year on year to reach £6.19 billion in 2017. However, France, Germany and The Netherlands are now the three largest Alternative Finance markets outside the UK, and Forbes predicts that although still a long way behind, growth in Europe is currently faster than the UK (Forbes 26/01/2018 Europe's Alternative Finance Sector Accelerates).
Having established what Alternative Finance is, let's get to the crux of the industry and analyse two similar sectors that you will read lots about;
P2P Lending – How is it best described?
"Now with the prospect of an 'out' Brexit looming, UK P2P platforms will be put to the test should the economy take an adverse turn" - from orcamoney.com (15/06/2016).
Peer-to-peer lending (P2P) is when businesses or individuals facilitate lending money to other business or individuals using an online platform which connects the two, much like a type of "e-cupid", with no other middle-man involved. Usually, loans funded by investors are secured against pledged assets that can then be sold at an auction to reimburse the investors should a loan default. As stated above, it is a rapidly growing sector due to banks becoming more conservative with their interest rates, but it should be stated that there are risks involved. Investors' capital is at risk should they choose to fund a loan as investments are not covered by the FSCS*.
Note: *See below section on Financial Services Compensation Scheme.
Property Crowdfunding – Is it different from P2P Lending?
"International investors pile into UK Property Crowdfunding" - from Peer2Peer Finance News (10/07/2019)
Property Crowdfunding is a similar mode of Alternative Finance to P2P lending. You may be familiar with the term "crowdfunding" and how it is simply the practice of funding a project by raising money from a large group of separate individuals or businesses, who each contributes a small amount of money to raise the total amount required. Property Crowdfunding uses this principle to develop plots of land and residential projects being built, or even homes that are fully built but being renovated, where investors can analyse different loans to fund and then lend the borrowers part of the capital they require. As in P2P lending, there are significant risks involved which should be taken into consideration. For more information on the differences between P2P lending and Property Crowdfunding, please read our blog post on this topic.
Now we have established the meaning of these three cornerstones to the Alternative Finance lexicon, let us address an initialism mentioned previously;
The FSCS – What does it do?
"The FSCS has already assessed and paid a number of claims made" - from fscs.org (12/09/2019)
The Financial Services Compensation Scheme (FSCS) was set up by the Financial Services and Markets Act in 2000 to compensate lenders in the event of an insolvency of any authorised financial services firm. Its compensation scheme covers deposits, insurance policies, investments and mortgages to name just some branches, and though it doesn't cover investment losses, it protects investors if they have been mis-sold any kind of policy or mortgage. According to Wikipedia, the FSCS "has helped more than 4.5 million people and paid out more than £26 billion".
Keeping the theme of regulatory bodies, on most, if not all P2P lending and Property Crowdfunding platforms, you will notice another initialism detailed below;
The FCA – Who are they?
"The FCA has today confirmed rules restricting the sale and marketing of contracts for difference" - from FCA (01/07/2019)
The Financial Conduct Authority is a regulatory body in the UK which operates independently of the British government, in order to maintain the integrity of the financial markets within the United Kingdom. All P2P lending and Property Crowdfunding platforms which are operated by a regulated firm, or are the appointed representative of a regulated firm, must announce on their websites that they are "authorised and regulated by the FCA".
This is intended to aid in the protection of consumers from fraud and scamming as the FCA can ban financial products for up to a year, and exercise its power to instruct firms to retract or modify promotions which it finds to be misleading. However, it should be noted that FCA authorisations or appointed representative status is not itself a guarantee of the success of an investment or investor protection. Whilst a firm may be regulated or may be the appointed representative of a regulated firm, that does not mean that a particular platform or investment is itself regulated.
According to fca.org.uk, the FCA is responsible for about 58,000 businesses which in turn employ 2.2 million people, contributing £65.5 billion in annual tax revenue to the UK economy.
The Capital Stack - What on Earth is it?
"Understanding your place in the 'capital stack' is one of the most important aspects of investing in property" – from MoneyWeek (13/07/2015)
Understanding a quote like this without knowing the meaning of the capital stack is virtually impossible. It loses all context so logically begs the question; "what is the capital stack?"
The capital stack is best described graphically as a tower which details the specific tiers of the investment into which the investors invest their money. These tiers portray the different levels of risk involved as a direct consequence to the subsequent level of returns gained. It is a hierarchy of creditors listed in ascending order under the hypothetical, but very possible situation of a loan defaulting. It is normally divided into four categories;
- Common Equity
- Preferred Equity
- Mezzanine Debt
- Senior Debt
The most important points to remember to understand how the Capital Stack works are that each level has seniority over all the capital sources located above it in the stack. Correspondingly, each capital source is subordinate to all the other levels located below it.
It must be noted that should a loan default, if there are insufficient funds to fully repay all the capital, as the risk increases the higher up the stack you move, then losses are incurred from the top down. As a result of this, potential returns on investments will increase the higher up the stack you invest.
SPV or SVE – What exactly does an SPV do and why is it important?
"Irish Special Purpose Vehicle assets reach €763 billion" – from The Irish Times (11/07/2019)
A Special Purpose Vehicle, almost always written as the initialism SPV/SPE (Entity), is a separate legal entity created by an organisation specifically to fulfil certain objectives. It is set up to be a distinct company with its own assets and liabilities as well as its own legal status. Usually, they are created to isolate financial risk from the organisation.
As it is a separate legal entity, if the parent company goes bankrupt, the SPV can therefore carry on its obligations. Investopedia describes this as being a "bankruptcy-remote entity".
Secured Loans – Need some examples of Secured Loans?
"...when choosing a secured loan, you should carefully consider what you will use as collateral." – from The Balance (09/12/2018)
At some stage, most of us will become involved in applying for a secured loan whether we know the intricacies or not. Maybe the best example of a secured loan is the mortgage you pay on your house. To strip it down to the basics, it is a loan where the borrower pledges an asset as collateral which secures the debt owed to the lender. To use our mortgages as an example, the collateral is the house in which you live, and should you not keep up with your monthly payments, the lender, probably a bank, can take the asset away.
Secured loans are very common in P2P lending, and pledged assets can be of a very high value. P2P borrowers can pledge assets like jewellery, gold or classic cars, so that in the event of a loan defaulting, the assets can be easily sold so lenders recover as much of their funds as possible.
Although interest returns are not as high as unsecured loans*, this option of lending is safer for the investor as there is collateral to recover if the borrower cannot keep up with loan repayments. Conversely, for the borrower, the risks are high, as despite interest payments being lower, there is a possibility that they could lose the asset, one example being their home.
Unsecured Loans – What's the difference?
"...many leading banks are now offering unsecured loans at interest rates as low as 11.49%" – from The Economic Times (12/10/2018)
Unsecured loans are loans that haven't been secured by an asset. As they are much riskier for the lender as there is no collateral to recover should the loan default, interest rates are usually much higher. It is normally only the signed contract detailing the specifics of the loan that serves as the legal document protecting the lender, though should the borrower not keep up to date with payments, their credit rating may be severely affected. Before entering into an unsecured loan contract, lenders will thoroughly investigate the creditworthiness of the borrower to analyse their own financial risk.
Should the loan default and the borrower cannot pay the lender their money, it is likely that the case will go to court. To avoid circumstances like these from happening, often lenders involved in unsecured loans request that a guarantor, sometimes a member of the borrower's family, promises to continue repaying the loan instalments in the case that the borrower cannot.
Despite being higher risk for the lender, recent data indicates that the unsecured loan market is growing. According to Investopedia, "Fintechs", or Financial Technology Firms, accounted for 38% of unsecured personal loan balances in 2018, up from just 5% in 2013.
Another recent example of unsecured loans having become more commonplace recently are Payday Lenders offering loans that will tide the borrower over until payday. Payday loan companies offer loans to borrowers which are unsecured, but often on hugely exaggerated interest rates*. As the loans are unsecured, if the borrower cannot pay back the loan, the lender cannot recover any assets, for example; the borrower's house or car. They are obliged to take other actions, usually seeking the services of Debt Collection Agencies, and even court action, where a tribunal may enforce that a percentage of the borrower's wages are paid back to the lender for a specific amount of time until their financial obligations are met.
Note: *According to The Money Advice Service, the average annual percentage interest rate could be up to 1,500% compared to 22.8% for a typical credit card. Now, the cost of payday loans is capped by law under the Financial Conduct Authority.
Dividends – How are they paid?
"Dividend income for holders of UK shares jumps to record £19.7 billion" – from The Guardian (15/04/2019)
An interesting headline indeed. Isn't it? Newcomers to Alternative Finance will almost certainly have heard of dividends but may not be immediately clear when pressed just how to explain exactly what they are.
From the Latin "dividendum", or "thing to be divided", put simply, a dividend is a sum of money paid by a company to its shareholders, usually once a year. The payments come out of the annual profits of the company, and upon receipt of the transfer into their account, shareholders would then pay income tax on any earnings over £5,000. Anything under this amount was taxed at 0%, which was the Dividend Allowance.
However, although this allowance has recently fallen to £2,000, according to Westlake Clark Chartered Accountants:
"The government expect that even with the reduction in the Dividend Allowance to £2,000, 80% of general investors will still pay no tax on their dividend income."
Even so, any dividend payments received over £2,000 will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% for additional rate taxpayers.
The shareholders always receive their fixed amounts depending on the number of shares they hold in the company.
Default – Is it the same as Bankruptcy?
"Property Crowdfunding lenders can be tied into contracts with borrowers with an increasing possibility of default" – from Quadrant (14/09/2017)
When lending money on a platform or investing capital into a project, the last thing you want as an investor or a lender is for the loan to default. A default occurs when the borrower has failed to meet his or her legal obligations according to the contract. This could be for a number of reasons, but is normally simply because they are financially unable.
The consequences of defaulting on a loan depend on the creditor and the type of loan. In most circumstances, the case is sent to a third-party credit collections agency and the debtor's credit rating is tarnished. Late payments and loan defaults can stay on credit rating reports for up to 10 years, meaning that it is then more difficult to find approval for separate financial products and will likely lead to higher interest rates on the debtor's credit card. It could even potentially affect job hunting as it is something prospective employers will consider.
It is important to consider that there are important differences between a default and other familiar terms with similar meanings, but specific differences. Wikipedia clarifies the following;
- A debtor has passed the payment deadline on a debt they were due to pay.
- A debtor has insufficient cash, or other "liquefiable" assets, to pay debts.
- A legal term meaning a debtor is unable to pay their debts.
- A legal finding that imposes court supervision over the financial affairs of those who are insolvent or in default.
In the majority of cases, the typical timescale preceding a loan default is that when the loan is at 90 days past due, the debtor becomes officially "delinquent". This means that the debtor's status with credit bureaus is "risky" and they will not be deemed creditworthy when applying for mobile phone contracts, direct debit payments with utility companies and credit card companies, to name some examples.
When the payment is 270 days late, it is officially "in default". This is the stage where collection agencies may get involved and charge further interest fees to cover their costs of collecting the money. The debtor will receive strongly worded and intimidating letters written principally in red ink, and it would certainly be recommended to seek the assistance of a financial advisor to help restructure your debt payments.
What's A Bridging Loan And Why Do People Choose Them?
"The market for bridging loans has grown steadily in recent years, especially in and around London, as borrowers try to complete property purchases quickly to secure their dream houses" – from Financial Times (03/02/2014)
Getting straight to the point, a bridging loan is a short-term loan which generally lasts from around a couple of months to up to two years depending on the specific conditions of the long-term finance agreement.
In te property development industry a bridging loan usually covers the shortfall between selling one property, and buying another. This means for example, that should you find your dream house which you want to secure quickly by purchasing it, all before managing to sell your current property, you may find yourself slightly short of funds. Therefore, a bridging loan may be the best option for you. It sounds like an attractive idea doesn't it? Unfortunately, typical bridging loans have much higher interest rates, so the shorter term you can negotiate, the better.
Interestingly, unlike other forms of borrowing, the monthly interest is often simply added onto the end of the loan, meaning there are no monthly instalments to pay during the loan term.
For the purpose of raising funds quickly, bridging loans are very useful, but there are potential drawbacks aside from higher interest rates.
As the loan terms are usually very short, should you not repay the amount owed at the end of the term, the penalties can be severe. You could incur major repercussions such as the repossession of your property, as well as significant tribunal fees.
What Does "Liquid Asset" Mean?
"The sum of all your assets, liquid or otherwise, minus the debts you owe, makes up your net worth" – from Quicken Loans (15/08/2019)
The term "liquid asset" conjures up worrying images of all your hard-earned possessions melting away. Although this is clearly not the case with this expression, the metaphor of liquid flowing freely and easily is not too inaccurate a description.
Liquid assets are simply assets that are easy to turn into cash in a short space of time, as they're deemed attractive or desirable. Within the P2P lending sector, some of these attractive and desirable assets which are easy to sell quickly would be jewellery or precious stones, gold, luxury watches, classic cars or even some fine art. They are all things for which you can imagine finding a buyer fairly rapidly would not be too difficult a task.
Liquid assets are important in case of financial emergency. Should the unfortunate situation of you needing to find cash very quickly arise, you probably won't have the time to put your property up for sale, dealing with all the necessary bureaucracy with which that comes. What you'll need is quick access to funds in order to keep the bailiff from the door.
In order to maintain a healthy financial profile, having assets which can easily be turned into cash in the event of a crisis will not only offer peace of mind, but will also potentially facilitate a rapid exit from unwanted financial problems.
So Conversely, What Are "Illiquid Assets"?
"Fund industry floats new structure for illiquid assets" – from The Financial Times (27/06/2019)
This beautifully crafted oxymoron between something floating and something "illiquid", expertly crafted by the literary powerhouse The Financial Times, introduces the topic of illiquid assets.
Having analysed what "liquid assets" are, we can maybe safely assume that "illiquid assets" are the opposite. They are assets that are somewhat trickier to convert into cash within a short space of time, loosely accepted at being around a year or more.
Perhaps the most obvious example of an illiquid asset is property of any description. Wherever you rest your head, whether it's your three-bedroom semi-detached in commuter-town suburbia, your end-of-row village cottage, your top-floor penthouse apartment in the centre of London, or your isolated farmstead thrust miles from civilisation, property, in general, is considered illiquid. Evidently, the spectrum is not black or white, and the scale of liquidity will increase depending on the more desirable your residence is. However, it will probably not sell as rapidly as a liquid asset like your solid gold watch.
Illiquid assets are important to offer diversity to your financial profile, thus mitigating risk. Whereas liquid assets are vulnerable to fluctuating markets, illiquid assets offer much more stability.
Who Are High Net Worth Individuals, And How Can I Become One?
"The High Net Worth Club has situated itself in New York City and London more than any other city" – from The Telegraph (03/02/2018)
So, who is this group? Who makes up the membership? Being a High Net Worth Individual (HNWI) is actually an official classification. If you have over $1 million dollars in liquid net worth, regardless of your status of birth, you classify as a HNWI. United States Dollars is the official currency gauge of determining whether you qualify or not, so although you have a One Million Zimbabwe Dollar bank note in your back pocket, it only relates to £2,282.13 and the banks won't grant you your membership card.
If you're unsure as to how many USD you own in liquid assets, have a look on the table below to see where you may fit in;
$1,000,000.00 is equal to:
- GBP 825,920.00 (Great British Pounds Sterling)
- EUR 901,455.00 (Euros)
- INR 69,589,073.44 (Indian Rupees)
- JPY 106,898,282.87 (Japanese Yen)
- AUD 1,472,007.08 (Australian Dollars)
- BRL 3,838,446.96 (Brazilian Reais)
- CHF 985,734.43 (Swiss Francs)
- ILS 3,499,405.93 (Israeli Shekels)
- RUB 64,870,670.76 (Russian Roubles)
- CNY 6,940,318.18 (Chinese Yuan Renminbi)
Note: *These values are correct as of 30/08/2019 and are subject to fluctuations.
Interestingly, in this blog we've talked about liquid and illiquid assets. The banks will only classify an individual as a HNWI if their liquid assets total over $1million. Therefore, your property, or more likely properties, will not be included in making up the $1million.
As the quote at the beginning of the section stated, most of the world's HNWIs are based in either New York City or London, around 393,500 and 353,600 respectively. The Far East (Tokyo, Hong Kong and Singapore) make up the next three cities in the top five, then back to the USA (San Francisco, Los Angeles and Chicago), then the Far East again (Beijing and Shanghai) complete the top ten. This information is telling about how wealth is distributed globally, with the combined total of all HNWI's net worth at an estimated $29.7 trillion, or 13% of the wealth on Planet Earth all situated in the same few areas.
What Does LTV Ratio Mean?
"LTV relaxed as home loans get cheaper" – from The Economic Times (02/08/2019)
Within the Property Crowdfunding sector, this is another initialism that regularly crops up because it is specifically to do with purchasing properties. It stands for Loan-to-Value ratio, and when buying a house, as moneyexpert.com (expertly) describes:
"The LTV ratio is the ratio between the value of the loan you take out and the value of the property as a whole, expressed as a percentage. The remaining value is paid as a deposit."
The Office of National Statistics recently released some data showing that the average salary in the UK is £29,009.00. In another study conducted by them, the average UK house price in 2019 is £229,431.00. It doesn't take a Mathematician to work out that it would take many years of fairly disciplined saving to buy a home outright. Therefore, logically, some kind of loan in the form of a mortgage is necessary.
To use a numerical example, if you want to buy a house for £350,000.00, and you've saved up £50,000.00 in your account as a deposit, you'll need to borrow £300,000.00 in order to purchase the property. Therefore, your LTV will be 85.7% as the bank will have to loan you 85.7% of the property value (£300,000 divided by £350,000, multiplied by one hundred to get the percentage).
Although largely considered to be a matter of opinion, depending on lending terms, interest rates, the exit strategies established, to whom and from whom the loan is being set up, and how illiquid the asset is, generally, an LTV below 80% is considered "low risk" from the lender's point of view, but over 80% would be "high risk".
As the risk is higher with higher LTV ratios, as expected, the interest rates are also higher. The less initial capital you have, the more you have to borrow, and the more interest you'll pay on it.
CGT – is it as complicated as it sounds?
"Capital gains tax cut will benefit richest 0.3% of population" - from The Independent (28/03/2016)
Capital Gains Tax (CGT) is not as complicated as it sounds, though it is well worth learning about. It is the tax you have to pay on the profit you make when you sell an asset. It's important to remember that it is not tax on the amount of money you receive from selling this asset, but just the profit made, so it is important to know for how much the asset was purchased. For example, if we imagine a Stradivarius violin as the asset in question, bought for £150,000, then sold for £250,000, you would be taxed on the profit of £100,000 made.
Before you despair at the thought of the government diving into your pockets just because you've completed a tidy deal, there are many circumstances when you don't actually have to pay CGT. The gov.co.uk website informs us that you must only pay CGT on the gain when you sell;
- Most personal possessions worth £6,000 or more, apart from your car
- Property that is not your main home
- Your main home if you've let it out, used it for business or it's very large
- Shares that are not in an ISA or PEP
- Business assets
However, you do not pay CGT on "gifts" to your husband or wife, civil partner or a charity. Neither do you have to pay it on certain assets, like gains made from ISAs or PEPs, Premium Bonds, or betting, lottery, or pools winnings.
Lastly, the CGT rate varies depending on your income and which income tax bracket you are in. For people paying basic income tax, the CGT rate is 10% or 18% on a residential property. Those on higher income tax rates will pay 20% on chargeable assets and 28% on gains made from a residential property.
How do you define an SME?
"Budget bonanza came at the right time for gloomy SMEs" - from The Independent (20/04/2016)
Small and Medium Sized Enterprises (SMEs) are independent companies which specifically employ fewer than a certain number of employees. Frustratingly, the actual number varies depending on which country's definition you are reading, but according to the European Union, (which means in the UK, for the time being at least), the number stipulated for a medium enterprise is set at up to 250 employees. Small enterprises officially employ up to 50 employees.
In larger countries, the United States being an example, the numbers are understandably set higher, and an American medium enterprise would consist of 500 employees.
Similarly, because of population demographics, in smaller countries (or geographically large countries with relatively sparse populations), SMEs make up the vast majority of the country's businesses. For example, in Australia and Chile, SMEs make up 98% and 98.5% respectively of those two countries' businesses, and in Australia's case, producing over a third of the country's total GDP whilst employing 4.7 million people of the 12.5 million Australians that are in employment.
Back home in the EU, there are certain types of assistance that SMEs can get if they apply for it;
- Eligibility for support funding under EU business support programmes
- Research funding
- Competitiveness and innovation funding that do not qualify as "state aid"
Finally, we must establish that it is not solely the number of employees that determine an SME. Technically, according to EU regulations, an SME should not have an annual turnover exceeding €50 million (about £40 million) or an annual balance-sheet total exceeding €43 million (about £34 million).
Although relatively small in size, SMEs play a vital role in the economy. Being generally entrepreneurial, they help to shape innovation and for that reason governments regularly offer incentives and favourable tax treatment.
What is an ISA?
"It's your last chance to get your savings locked away into an ISA, but you need to act quickly" – from isa.co.uk (21/03/2019)
Another acronym for the Jargon-Buster to decipher. The Individual Savings Account allows UK residents to save money tax-free into a cash savings or investment account. Although there are numerous different types of ISAs, the Jargon-Buster will try to simplify the definitions for the purpose of clarity.
Cash ISAs – basically the same as a traditional savings account for anyone over 18 years of age, but with a limit on the amount of cash you can deposit in each tax year (£20,000), and no tax is paid on interest. Cash ISAs are divided into;
- Instant-access cash ISAs
- You can pay in money and withdraw money at any time.
- Regular savings cash ISAs
- Usually pay a fixed rate of interest over a certain time on the proviso that you pay in a certain amount of money each month. (You can contribute £1666 each month without breaching the £20,000 annual limit).
- Fixed-rate cash ISAs
- You'll need to commit to locking your money away for a fixed amount of time in order to be rewarded with a higher interest rate. Generally, the longer the term, the more interest you'll earn.
- Stocks and shares ISA
- This is an investment account where all capital gains are protected from tax. As with a cash ISA, you can pay in £20,000 during one tax year. Usually, you can choose between managing your investments yourself, or, for a fee, having them sorted for you. There are risks involved with stocks and shares ISAs, and as with any form of investment, you may get less capital back than the amount you put in.
- Innovative Finance ISA
- Known as an IFISA, this is used frequently by borrowers who did not want to get a traditional bank loan, maybe for property development projects or small business looking to expand. It connects them with lenders, who will receive a rate of interest when the borrowers pay back the money invested. Normally, the higher the interest rate, the higher the investment risk.
- Help to Buy ISA
- Is a government-backed ISA savings account to help first-time buyers get on the housing ladder. Upon opening the Help to Buy account, you can deposit up to £1200, then pay in £200 a month thereafter. This means that in the first year, you can save up to £3400. The government then pays a 25% bonus on what you save up to a maximum of £3,000.
- Lifetime ISA
- Aimed at anyone between the ages of 18-39, this is another government-backed scheme to help people in their retirement. The government will pay a 25% bonus on whatever you save up to a maximum of £1000 each year. If you're using this ISA for your retirement, you can only pay into the account until you're 50, and must wait until you're 60 to be able to withdraw it.
- Junior ISA
- The Junior ISA is for under 18s and offers an option for a parent of legal guardian to pay in money each year until the child is 18 years old, when it then turns into a normal adult ISA.
Negative Equity – is it as bad as it sounds?
"Negative equity afflicts half a million households" – from BBC News (01/03/2017)
In essence, this is bad, and if you're a homeowner, you certainly do not want to have negative equity on your house. It is when the market value of the house falls below the outstanding amount of the mortgage left to pay. This renders the property very difficult to sell without making a huge loss, as trying to sell it with a depreciating value is only slightly less frustrating than continuing to pay the (expensive) mortgage off knowing that the house is not worth what you're paying the bank each month.
It's caused by falling property prices and within the UK, some regions are far more affected than others. One area of the UK where the problem has escalated rapidly is Northern Ireland, where around 40% of every property bought after 2005 is in negative equity.
What worries most people about being in negative equity is whether you will lose your home. You will not, as long as you continue to keep up with your mortgage repayments. In fact, the faster you repay your mortgage repayments (some lenders accept overpayments if the borrower is financially capable), the faster you will be out of negative equity as the mortgage diminishes quicker, to be less than the value of the house again. Otherwise, with property prices fluctuating all the time, another answer is just to sit it out and wait until local house prices in your area rise again. Life, in the meantime, can be stressful and expensive though.
Lastly, once again, it seems to be people in the North as well as Northern Ireland who suffer more than Southerners. Statistically, if house prices were to fall by 10% in the whole of the UK, while about 10% of people in the North would be plunged into negative equity, just 0.03% of Southerners would suffer.
Stamp Duty Land Tax – why is it necessary?
"Stamp Duty abolished in Budget 2018 for all first-time buyers of shared ownership properties up to £500,000" – from Home&Property (29/10/2018)
The question "why is stamp duty necessary?" is one about which many homeowners could become quite vocal. It is often the final straw for people who have gone through the stress of looking for, bidding for, and negotiating over a property, whilst planning how to extend or redecorate it, suffering teeth-gnashing delays and setbacks, then exasperatingly paying out large sums of money to people whom you've never met but whose principal role in the whole process was to sign a piece of paper or send a form. Then, you are told to pay Stamp Duty.
Stamp Duty fees do vary however, and if you manage to find a residential property for under £125,000, you don't have to pay Stamp Duty at all.
First-time buyers also get a discount on Stamp Duty Land Tax (SDLT), and if the property is under £300,000, there's no SDLT to pay at all. This could mean that first-time buyers save thousands of pounds when everything is worked out.
Let's say, for example, that you buy your second house for £275,000. SDLT is calculated as follows;
- 0% on the first £125,000 = £0
- 2% on the next £125,000 = £2,500
- 5% on the final £25,000 = £1,250
Total SDLT to pay = £3,750
Despite all the reduction schemes and incentive programmes to reduce SDLT for people purchasing property, if you've shelled out a hypothetical £41,250 as a 15% deposit on a £275,000 house, then paid countless estate agent fees, solicitors, brokers, surveyors, removal companies etc, then £3,750 extra when you think it's all over, can seem deflating.
As if this isn't enough, whereas we once had 30 days to pay the SDLT after completion of the purchase, this has been reduced to 14 days from 1st March 2019. Should you neglect to pay the SDLT, HMRC will contact you at your new address charging you penalties and interest.
What is an AML check?
The Financial Action Task Force (FATF) recognises that the UK's AML regime is the strongest of any country assessed to date – from www.icaew.com (12/03/2019)
An AML or Anti-Money Laundering check is a formal assessment carried out by a business to make sure that an investor or client is who they say they are, and that they are not investing on behalf of someone else. It refers to a set of laws, policies and regulations aimed at combating income being generated in a fraudulent way.
Completing AML checks form a large and important part of companies and platforms carrying out their Customer Due Diligence procedures in order to identify the people who are using the business.
These Customer Due Diligence procedures will be applied when any type of business relationship is established between a company and a customer or when an existing customer's circumstances change, and records need to be updated.
Customers will typically need to provide;
- Photo ID (national identity card bearing a photograph, or full driving licence)
- Proof of address (utility or council tax bill issued within the last three months or electoral register entry)
- Date of birth (valid passport or original birth certificate)
Companies will sometimes conduct additional credit checks using credit agencies like Experian.
After these checks, should the company still have doubts over the legitimacy of the customer, they reserve the right to not deal or trade with them in any way.
Anti-Money Laundering procedures cover a huge range of implementers, and it is not solely businesses and Alternative Finance platforms who conduct the processes. Whole financial institutions, and even National Governments must adhere to the procedures, to prevent the transformation of profit from illegal activities into the proceeds from lawful sources, and to detect suspicious money transactions and activities in order to stop business crimes and financing terrorism.
How is a KYC check different?
All financial institutions must carry out stringent KYC checks on all new customers before handling their money – from The Telegraph (23/11/2018)
KYC or Know Your Client checks that companies carry out on their investors and customers also form an important part of platforms completing their risk assessment analyses and Customer Due Diligence processes. To avoid over-complicating things, we can say that the KYC check makes up one part of the bigger AML procedure, much like a smaller cog in a larger machine
Therefore, the terms "AML checks" and "KYC checks" are not to be used interchangeably as there is an important distinction. Whereas AML procedures are used in the context of the overarching governance framework that a regulated entity constructs in order to meet its regulatory requirements, KYC is simply a set of tools and processes within the AML framework.
The implementers must gather information about their clients to verify their identities, in order to be certain that business partners and counterparts comply with anti-bribery standards.
What is a debt-based investment?
Such debt-based investments have become far better known since HMRC ruled last year that they could now be included in Innovative Finance ISAs – from www.triplepoint.co.uk (18/10/2017)
The debt-based investments that you can find on the CrowdLords platform will either come secured via a 1st charge or a 2nd charge. These charges are directly linked to the Capital Stack. Debt investments secured via a 1st charge form part of the Senior Debt, and should the loan default, investors will be repaid before any other level of the stack, should there be enough funds to do so.
Debt investments secured via a 2nd charge form part of the Junior, or Mezzanine Debt, and though considered lower risk than an equity investment, in case of indebtedness, investors will only receive any repayments after the Senior Debt obligations have been met.
As a result of this hierarchy, the interest returns for Mezzanine Debt are slightly higher than Senior Debt, but the risk is considered slightly higher.
Very simply, when you invest via debt-based investments, you are simply loaning the money to the borrower and receiving a rate of interest when the borrower pays back the money at the end of the term.
With a debt investment, your profit is not directly related to the performance of the borrower. If you buy a £5,000 corporate bond from a company and that company then makes a record profit, your profit is the same as they had earned no profit at all. On the other hand, there is always a risk with debt investments that the borrower will be unable to pay back the debt. If the borrower doesn't have the money to pay their lenders or if they file bankruptcy to legally avoid paying their lenders, you could be faced with a complete loss of your investment.
What is an equity investment?
Historically, equities have outperformed safer investments, such as bank accounts and bonds, and can act as the real driver for growth in your investment portfolio – from www.which.co.uk (01/01/2019)
When you invest via equity, you could consider yourself as being more financially committed than debt-based investors. Investors become shareholders in an SPV which owns the property and their returns depend on the profits generated by the development project, in proportion to how much you invest. You even enjoy shareholders' rights. This means that the risk is higher, but the rewards can be greater.
As with debt investments, there are different types of equity investments with varying degrees of risk involved. Preferred equity, as per the Capital Stack is considered less risky than Common equity because in the case of a default on the loan or even bankruptcy, Preferred equity investors will be repaid before Common equity investors, should there be sufficient funds to do so.
With equity, put simply, if you buy a hot-dog stand, your profit is based upon the net revenue of that hot-dog stand. If you become the part-owner of a company by investing in equity, you enjoy the potential growth of the company, or suffer the losses it incurs.
Equity based investments are seen as higher risk and therefore typically earn a higher rate of return than debt investments.
Capital – is it the same as cash?
The Financial Crash in 2008 showed is what can go wrong when the banking system has too little capital – from www.bankofengland.co.uk (10/10/2019)
In short, no it is not. Capital is another name for the financial resources an individual or a company has that act as a cushion or shock-absorber against unexpected losses if someone fails to repay their loan.
It's easy to consider cash and capital as the same thing, but it's actually a common misconception. It's like considering "Samsung" and "television" as the same thing, where in reality Samsung does not only make televisions, but produces many products. In the same way, capital includes cash, but it also includes many other things. It refers to the difference between your total assets and your total liabilities.
Scottish economist Adam Smith defines capital as:
"That part of man's stock which he expects to afford him revenue."
Meaning that for a hunter, his bow and arrow could be considered capital, or for a tennis player, likewise his or her racquet.
What's the difference between "yields" and "returns"?
10-year Treasury yield pushes above 1.6% after European bond-market selloff spills into U.S. – from MarketWatch (10/10/2019)
Basically, a return is the gain or loss on an investment, whereas the yield refers to the income returned on the investment.
The return is generally retrospective as it shows what has been earned in the past. The yield looks to the future as it is an expression of what will be earned (generally expressed as a percentage).
Like "capital" and "cash", it is a common misconception that they are the same thing, and are often incorrectly interchanged.
In financial terms, the yield, according to Wikipedia is as follows;
"In finance, the yield on a security is the amount of cash (in percentage terms) that returns to the owners of the security, in the form of interest or dividends received from it. Normally, it does not include the price variations, distinguishing it from the total return."
The yield is a major decision-making tool used by both companies and investors alike, and is a huge influencing factor in financial choices made. The financial ratio indicates how much a company pays in dividend or interest to investors, each year, relative to the security price. Yield is a measure of cash flow that an investor is getting on the money invested in a security.
What are PBSAs and who lives in them?
"Why 2020 could be a strong year for the UK's PBSA sector" - from Property Investor Today (13/12/19)
PBSA or Purpose Built Student Accommodation is a term which refers to residential properties where 'common areas' exist and are shared by more than one occupant.
PBSAs are specifically built for students by private commercial developers and usually take one of two forms.
Self-contained studio or "cluster" flats with private kitchens but shared living space.
Modern halls of residence containing ensuite bedrooms with a shared kitchen, dining and living facilities.
One advantage of living in an PBSA is that it is affordable. If you're a student for example, renting a property on your own while at university is simply too expensive. However, opting for a PBSA can provide you with an affordable option when it comes to accommodation.
Another advantage of a PBSA is having your property professionally managed either by a landlord or a property management company. This means that any problems are dealt with promptly and if anything breaks down, typically boilers or kitchen appliances, the management is obliged to solve the problem quickly.
Of course, the downside to living in a PBSA is the lack of privacy. Of course, you have your own bedroom as personal space but you can't have a night in on your own watching the film of your choice in the living room or enjoy an intimate dinner with a loved one, because you have other people using the facilities too.
Build to Rents... Who are they for?
"Construction of build-to-rent homes increases by 40% in the UK, research shows" - from Inside Housing (17/01/19)
The Build to Rent scheme was launched in 2012 as part of a series of government initiatives to increase the supply of high-quality homes available for market rent in the private sector.
They are basically private, rentable residential properties which have been built specifically for the purpose of being rented rather than sold. So, in short, they're affordable homes that have been built just for the rental market, and are normally owned by a company rather than an individual landlord.
Tranche Payments, how are they different?
"Tranche warfare breaks out over CDOs" - from Financial Times (14/4/08)
A tranche payment refers to the staged release of funds used to fund property developments.
Coming from the French "slice", Investopedia explains that:
"Tranches are pieces of a pooled collection of securities, usually debt instruments, that are split up by risk or other characteristics in order to be marketable to different investors."
Each portion, or tranche, is one of several related securities offered at the same time but with varying risks, rewards and maturities to appeal to a diverse range of investors.
Examples of financial products that can be divided into tranches include bonds, loans, insurance policies and mortgages.
Ever heard of a 'Drawdown'?
"Drawdown popularity rises again" - from Money Marketing (06/08/19)
The term drawdown most commonly refers to the process of moving funds from an individual account to another.
For example, at Crowdlords, it is simply when we move money from the platform's e-wallet to the SPV bank account so that the developers can then use the funds to finance their projects.
Provisions – are they anything to worry about?
"RateSetter defends provision fund against claims it is running dry" from Peer2peer Finance News (13th January 2020)
Provisions are a necessary part of finance insofar as they form the base of safeguarding against loss. If the borrower is unlikely to be able to repay the full value of the loan, a provision to cover the losses may need to be made.
A provision needs to be prompted by an event that causes the investor to believe that he or she is not going to recover the full value of the investment.
Write-off – what exactly does it mean to write off?
"Lloyds to write off debts worth tens of millions" from Sky News (23rd January 2020)
Writing something off is essentially a decision by a company or business to cancel a debt or an amount of money once the borrower cannot repay the amount of money they borrowed.
If the borrower is not able to repay the full value of the loan, and the lender accepts that they will never be able to recover the amount lent, the company will write off the money or assets from the ledger to reduce the overall tax liability.
The best example of a write-off is a bad debt. A bad debt is an account receivable that can no longer be collected. In other words, the company or customer that owes you money either refuses to pay or is unable to pay back the money it owes. Rather than keeping this bad receivable on the books, companies simply remove it.
Refinancing – Can anything be refinanced?
"With mortgage rates so low, is now a good time to refinance?" from Forbes (2nd March 2020)
Refinancing is to finance something again using a new loan or other form of investment, typically at a lower rate of interest.
This financial structure is often used to replace an existing loan with a cheaper form of finance or to consolidate existing borrowing. It's a good idea for borrowers to refinance in order to receive more attractive interest rates, therefore reducing their repayment amounts.
A refinance involves the reevaluation of a person or business's credit terms and credit status.
Consumer loans typically considered for refinancing include mortgage loans, car loans, and student loans.
Social impact – How finance can affect everyone
"Firms join goverment-backed social impact investing taskforce" from Civil Society News (24th April 2018)
There is no standard definition of social impact, but it can be defined as the effect on people, community or society that happens as a result of an action, activity, project, programme or policy.
Some contemporary examples of social impact with development projects may be the UK's current plans to expand Heathrow Airport and the evident impact on the local people, or the building of HS2 and its detrimental affect on the countryside and wildlife.
Property Crowdfunding always has to consider the social impact of the property development projects it helps to fund and the subsequent social outcomes, financial returns and benefits expected from the investment.
Why are fees necessary?
"Savers and pension holders wasting thousands of pounds on hidden investment fees, research reveals" - from The Independent (11/07/19)
Fees – The word "fees" usually triggers an instant groan from most people. It indicates an extra cost that you probably hadn't factored in previously, making your purchase or investment more expensive than you may have thought. "Administration fees" is a common example of adding a little extra on at the end, pushing up the amount to pay a little further. They are normally paid to the people typing out the contracts and doing the paperwork, who generally, aren't just doing it for the love of doing it.
But what are fees in Alternative Finance? Essentially, they're charges, and expenses incurred as part of the investment agreement. Other examples include "arrangement fees" (payable at the beginning), "facility fees" (e.g. the cost of having an overdraft facility) and "early repayment fees" (a penalty fee to compensate the investor for potential loss of interest payments).
What's a Rent to Rent (R2R)?
"Government to challenge High Court ruling which found Right to Rent caused racial discrimination and violated human rights law" – from The Independent (15/01/20)
R2R (Rent to Rent) also known as guaranteed rent, whereby you make an agreement with a landlord to manage and pay a fixed rent on their property for a period of time. You then rent out the property at a higher rate.
You can achieve this by setting the property up as serviced accommodation or by converting that property to an HMO. The landlord has a guaranteed income with no property management to deal with and you're able to make a profit.
What is Serviced Accommodation (SA)?
"Staycity shuts Birmingham SA as coronavirus hits occupancy" – from Birmingham Mail (16/03/20)
Serviced accommodation is fully furnished property which is available to rent either short or long-term via websites such as Airbnb or Booking.com.
It may provide hotel-like amenities such as room service, housekeeping, a laundry service, as well as a concierge or gym.
Most of them are equipped with full kitchens and Wi-Fi.
Companies frequently use SAs to host professionals who may be on a local or international work assignment, but they're available for members of the general public too. It is common for executives to stay in SAs temporarily while searching for a permanent residence or relocation as they provide more space, privacy and luxury than hotels.
What exactly is an investment fund?
"Fund manager channels fees to tackle Coronavirus in developing world." - from The Guardian (08/04/2020)
An investment fund is a supply of capital belonging to numerous investors used to collectively purchase securities while each investor retains ownership and control of his or her own shares.
A fund itself could best be described as a professionally managed pool of money that is allocated for a specific purpose, whether a city government decides to set aside money to build a new civic centre, a college raises some money to award a scholarship, or an insurance company allocates money to pay its customers' claims.
Do you know what working capital is?
"There are always new ways to make the most of working capital." - from Entrepreneur Europe (22/04/2020)
Working capital is the funding required to cover short term operational costs like paying salaries, whilst managing the timing differences of income and expenditure.
It can be used to support an organisation while it raises money or generates income to cover its costs in the longer term or can be a short term arrangement like a bridging loan or overdraft facility.
First loss - what are the advantages?
"Increased interest in first loss platforms has been seen from investors and the media of late." - from Aurum (15/11/2018)
First loss investors are the investors who agree to bear the "first loss" on an investment to provide protection to other investors. First loss investors are at a greater risk of losing their money and are usually offered a higher rate of return if the investment is successful.
Aside from seeing potentially greater returns if the investment is successful, another advantage is that first loss investors encourage the participation of co-investors that otherwise may not take part in the loan.
What exactly is a bond?
"Should you buy bonds with yields this low?" - from Marketwatch (22/04/2020)
Aside from being a martini drinking British spy and a place on the Monopoly board, bonds are a specific type of loan, usually used as an alternative to borrowing from a bank.
The borrower is known as the "issuer" of the bond and the lender is the holder. Interest on the bond is known as the coupon. Interest is usually paid at fixed intervals until the issuer of the bond agrees to repay the original loan amount at a specified time, known as maturity.
Underwriting - as complicated as it sounds?
"Figures released this week showed that only £1.1bn of loans had been granted to small firms under the Coronavirus business interruption loan scheme (CBILS), despite the Treasury pledging to underwrite 80% of the cost." - from The Guardian (17/04/2020)
Underwriting is the process that a lender or other financial service uses to assess the creditworthiness or risk of a potential customer. This risk typically involves loans, insurance, or investments.
It involves accepting the complete liability of the loan or taking on the entire financial risk for an investment.
Interestingly, the term underwriter originated from the practice of having each risk-taker write their name under the total amount of risk they were willing to accept for a specified premium.
As you delve deeper into Alternative Finance and Property Crowdfunding, it's likely that you'll increase your understanding of the terms and expressions involved as well as the contexts in which they are used. If you're interested in starting up as an investor in the Property Crowdfunding sector, it's vital to know about all the components which comprise Alternative Finance as it does contain high risks and lack of knowledge can be costly when investing your personal capital.
However, we'll keep updating this Jargon-Buster blog every week with new examples so feel free to click on the link and read more.
- Is post-war property a good investment?
- Can post-coronavirus unused office space resolve a nation's housing crisis?
- Are you an optimist or a pessimist in Property Crowdfunding?
- Need a hand with puzzling alternative finance jargon?
- Seven myths and one truth about Property Crowdfunding
- Understanding Loan to Value (LTV) - Part II
- Understanding Loan to Value (LTV) - Part I
- Construction workers given the green light to work despite the Coronavirus pandemic
- Is Coronavirus likely to slow down growth in the UK's property market?
- How the decline of UK's High Streets is opening the way for UK property developers
- Who should you turn to for investment advice before Property Crowdfunding?
- Is property crowdfunding a viable way to get onto the property ladder these days?
- The importance of liquidity in your investment portfolio
- FCA guidance changes ring in the new year
- Gender stereotypes in Alternative Finance; are women playing catch-up?
- How does CrowdLords compare?
- Brighton Road - Meet the Developer
- Property Crowdfunding; A Global Appeal for UK Platforms?
- Does the future of Property Crowdfunding lie in the hands of Millennials?
- Meet the Developer - Jo Hagan (5 Mentmore Terrace)