Discover your inner loan shark with prosper.com
Last summer I began to research prosper.com, a site that specializes in peer-to-peer (P2P) lending. Essentially, it's the ebay for personal loans; except with 'wanted' listings instead of 'for sale' listings. In your listing, you can include a picture and give an open-ended explanation of your credit history, your plans for the money, and your current financial situation. Prosper.com claims to cut out the middle man (well, except for the new middle man: prosper.com) and is able to help people with all different levels of credit get a cash loan for a lower interest rate than they would find with a traditional lender. Additionally, those willing to invest (partially funding loans with as little as $50) are likely to earn a better return on their money than they would by placing it in a bank, mutual fund, or stock.
One can loan his money to an extremely low-risk borrower -- one with a 2% chance of defaulting -- and earn about 8% on his money. Or with a high-risk borrower, he can earn up to 35% return! To put that in perspective, I just received my 401(k) quarterly statement and found that my quarterly earnings were -.29% (that's negative-point-two-nine, not negative-twenty-nine...I'm not THAT bad at investing). If he wants, the lender can spread his loans out, $50 at a time, for no extra cost. So if there are no added costs to diversify, the returns are above average, and the risk is relatively low, why hasn't everyone signed up with a prosper.com account? I'll tell you why.
The thing is, prosper.com isn't really an apples-to-apples-comparable investment to something like a CD, savings account, or a stock. All of those things can be turned in for cash at any point (possibly with a penalty or sales fee), having nearly the same liquidity as cash; and liquidity isn't free! Let's not forget that savings accounts and CDs are FDIC insured, too.
Loans made on prosper.com all have a term of three years. So a prosper.com investor will receive a monthly payment (which includes interest) each month for three years unless the borrower pays the loan back early.
This brings up another interesting difference between prosper.com loans and traditional savings/CD accounts. It's not as easy to compound your interest earned with a prosper.com loan. As a bank investment will automatically start paying you on your earned interest, prosper.com just deposits cash into your account. Because of this, that money will sit sans interest until you take the time to reinvest it. This means that once a month you need to find another borrower to whom you can lend your money. And because each loan has a different due date, to maximize your return, you'll need to find new borrowers for the interest you earned on each of your current loans.
So am I saying that you shouldn't invest your money in prosper.com? Absolutely not. Am I saying that it cannot be compared to savings and CD accounts? Well, I'm saying that it can't be looked at in the same way. All investments can be compared, whether you're putting money into a 401(k), buying stocks, or raising and selling cattle. What must be analyzed when comparing investments is the risk, the return (the only two things people tend to look at), and the liquidity and fees associated with the investment. Like all investments, prosper.com loans require tender care and maintenance. You get a higher return because 1) YOU perform that maintenance (instead of paying a bank of a mutual fund to do it) and 2) the liquidity of your loans are very limited.
As much as people tend to hate banks, they do provide a service. We never have to worry about reinvesting our interest and we're welcome to come any time and take our money out. In fact, they make it easy for us by giving us checks and debit cards. But banks charge us dearly for these services -- a point that's proven by prosper.com. When a borrower is willing to borrow at 10% and a bank is willing to pay 1-3% in interest, it's not hard to figure out how much a bank charges for its services.
If you want to lend with prosper.com (I haven't yet), go ahead -- it's quite an opportunity. But do it with the understanding that your returns will not be compounded unless you are a disciplined caretaker of your account. And be sure to only invest an amount of money that you have 'forgetten' about and would not need in the event of an emergency. Also, be sure to check out http://www.ericscc.com, which is a neat site dedicated to the analysis of individual lenders' successes and failures on prosper.com. Study the best and worst lenders and find what their strategies have been.
Borrowers: Sorry, but I don't have any advice for you. If you'd like to borrow $10,000 at 35% interest to 'pay off credit cards with high interest,' you've got some serious problems.
One can loan his money to an extremely low-risk borrower -- one with a 2% chance of defaulting -- and earn about 8% on his money. Or with a high-risk borrower, he can earn up to 35% return! To put that in perspective, I just received my 401(k) quarterly statement and found that my quarterly earnings were -.29% (that's negative-point-two-nine, not negative-twenty-nine...I'm not THAT bad at investing). If he wants, the lender can spread his loans out, $50 at a time, for no extra cost. So if there are no added costs to diversify, the returns are above average, and the risk is relatively low, why hasn't everyone signed up with a prosper.com account? I'll tell you why.
The thing is, prosper.com isn't really an apples-to-apples-comparable investment to something like a CD, savings account, or a stock. All of those things can be turned in for cash at any point (possibly with a penalty or sales fee), having nearly the same liquidity as cash; and liquidity isn't free! Let's not forget that savings accounts and CDs are FDIC insured, too.
Loans made on prosper.com all have a term of three years. So a prosper.com investor will receive a monthly payment (which includes interest) each month for three years unless the borrower pays the loan back early.
This brings up another interesting difference between prosper.com loans and traditional savings/CD accounts. It's not as easy to compound your interest earned with a prosper.com loan. As a bank investment will automatically start paying you on your earned interest, prosper.com just deposits cash into your account. Because of this, that money will sit sans interest until you take the time to reinvest it. This means that once a month you need to find another borrower to whom you can lend your money. And because each loan has a different due date, to maximize your return, you'll need to find new borrowers for the interest you earned on each of your current loans.
So am I saying that you shouldn't invest your money in prosper.com? Absolutely not. Am I saying that it cannot be compared to savings and CD accounts? Well, I'm saying that it can't be looked at in the same way. All investments can be compared, whether you're putting money into a 401(k), buying stocks, or raising and selling cattle. What must be analyzed when comparing investments is the risk, the return (the only two things people tend to look at), and the liquidity and fees associated with the investment. Like all investments, prosper.com loans require tender care and maintenance. You get a higher return because 1) YOU perform that maintenance (instead of paying a bank of a mutual fund to do it) and 2) the liquidity of your loans are very limited.
As much as people tend to hate banks, they do provide a service. We never have to worry about reinvesting our interest and we're welcome to come any time and take our money out. In fact, they make it easy for us by giving us checks and debit cards. But banks charge us dearly for these services -- a point that's proven by prosper.com. When a borrower is willing to borrow at 10% and a bank is willing to pay 1-3% in interest, it's not hard to figure out how much a bank charges for its services.
If you want to lend with prosper.com (I haven't yet), go ahead -- it's quite an opportunity. But do it with the understanding that your returns will not be compounded unless you are a disciplined caretaker of your account. And be sure to only invest an amount of money that you have 'forgetten' about and would not need in the event of an emergency. Also, be sure to check out http://www.ericscc.com, which is a neat site dedicated to the analysis of individual lenders' successes and failures on prosper.com. Study the best and worst lenders and find what their strategies have been.
Borrowers: Sorry, but I don't have any advice for you. If you'd like to borrow $10,000 at 35% interest to 'pay off credit cards with high interest,' you've got some serious problems.
posted by Scott Bliss @ 6:06 AM
4 Comments:
At July 30, 2008 1:15 PM ,
Steve said...
Well, Scott, after reading your post in full, you got some things wrong. (I had only read the first paragraph or two when I talked to you this morning)
Mainly, you CAN have Prosper automatically re-invest your money as payments come in. You can set up 'portfolios' with custom settings for finding loans to bid on. You use things like loan amount, interest rate, borrower's credit rating, revolving credit, defaults, homeowner/not homeowner, loan type (business, credit consolidation, etc), and many others. Based on those variables, you can set up a portfolio that automatically invests in loans that meet your custom criteria. You can even set up multiple portfolios with different criteria and assign a percentage of your capital to invest in each. The minimum bid of $50 still applies, so the portfolios will sit around until that amount is available. Using the portfolios, you never have to look at a loan listing if you don't want to - you can use them to invest your initial capital as well as re-invest money that comes back.
That said, I don't do it. I don't have enough money in Prosper to make it worthwhile. Plus, I think it is absolutely fascinating to look through loan listings and pick ones to bid on.
I've got $500 invested in prosper at the moment. I started with the minimum first transfer of $250 to start an account, loaned $50 to 5 different people, and sat back and watched. After about 3-4 months, I put in another $250 and lent to 6 more people using the new money as well as payments that had come in.
Now, with 11 loans, I am averaging about 21%. With the current level of principle on each loan, I earn 34 cents in interest each day.
I haven't had any problems yet, which I attribute partially to the loans all being fairly new, and partially to how I pick people I loan to. I have mostly made loans that claim to be for a small business and try to choose people that have a secondary source of income from that company - spouse's income or a steady day job. I also prefer homeowners with a low level of revolving credit and no defaults. In my mind, this helps me choose people that have proven they can pay off debt responsibly, and are seeking capital to improve their current level of income, not minimize debt they have allowed to pile up. Prosper is a very good option for people like this - they can get a small loan quickly (a week or less) for things like renovation of a storefront or extra inventory for a holiday season. Because of the quick turnaround and no penalties for early payment, Prosper is a great option for business or personal emergencies, like roof repairs.
You are very right that you can't compare prosper directly to other investments, largely due to the liquidity factor. You have to be absolutely confident that you won't miss the money.
This makes Prosper a good option only in certain investment cases. I currently do 3 things with my spare money - savings, stocks, and Prosper. I've barely put anything in Prosper. One thing I'm considering is putting $50-$100 a month into it. This is a very affordable amount for me. The goal of this would be for long term, high interest, medium risk investment. This could eventually be funds for my kid's college, house payments, etc. If I can start putting more in, it could be a way of setting up a low level secondary income.
Prosper is also a good option if you have enough savings to drop a large lump sum in. If you diversify your loans well, you'll end up with an aggregate interest rate of about 12-20%. The way this works out, you'll have gotten your principle back in about 2 years or a little longer, and the rest of the payments are your profit. I think it would be reasonable to do something like put 2 years worth of utility payments and put it all in Prosper. You could then use the monthly payments to pay for the next ~2.5-3 years of utilities. I think a decent way of looking at Prosper is trading a lump sum for monthly payments. The monthly payments add up to more than the lump sum, but you gotta wait on them.
OK, enough rambling, and I'm done with lunch. I didn't read this through or edit it at all, so sorry if anything is incoherent.
Steve
www.iHateWheat.com
At July 30, 2008 1:29 PM ,
Steve said...
Oh, I meant to add that your last comment,
"Borrowers: Sorry, but I don't have any advice for you. If you'd like to borrow $10,000 at 35% interest to 'pay off credit cards with high interest,' you've got some serious problems."
is a bit off. There are people trying to do things like that, but they are the extreme outlier as far as borrowers go. Lenders are pretty careful in vetting borrowers, so this type of listing will not get enough bids to be funded 99.9% of the time.
Another interesting part in the lending/bidding process is the opportunity to ask borrowers questions. This allows the lenders to better establish who they are lending to and what the borrower's situation is. It helps borrowers get out from under tough situations - they get a chance to explain a default or high revolving credit. If a borrower has a default because their now ex-wife stopped making car payments while they were on tour in Iraq, Prosper lenders will be able to take that into account, not just see a big X on the borrower's record. People can also vouch for borrowers. And, borrowers can join groups. Groups have aggregate ratings that depend on their member's payment records and therefore carefully examine members' situations. If a borrower in a group misses a payment, people in the group will talk to them, remind them, give them advice, etc. These aspects give Prosper a social aspect that is not present in normal banks. In my little experience, this makes Prosper better for both borrowers and lenders and helps ensure the deal is good for all involved.
At July 30, 2008 1:42 PM ,
Steve said...
Also forgot to mention - the biggest upside of Prosper is that it is 100% transparent to both the borrower and lender. That is absolutely unheard of in the banking and lending industry, as far as I am aware.
At August 1, 2008 3:05 PM ,
Scott Bliss said...
I just found a neat link if you're interested in trying out prosper.com...
How about a prosper.com simulator?
http://www.fantasyprosper.com/
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