Prosper.com: Convincing My Wife, Part 3

Side note: If you're browsing Prosper.com, check out their ad for "PayDayMax.com" where you can get a 7-day loan for only 970.9% interest! It's a super deal if you're strapped for cash!

Now back to convincing my wife that we should invest on Prosper.com...

Today I'm going to discuss some of the things that give me confidence in a borrower and some of the things that raise flags. I'll also highlight some general rules of thumb that will increase your chances of establishing a pattern of profitability on Prosper.com.

Loan characteristics that give me confidence:

1. Specificity -- especially by low-credit borrowers. I am more encouraged to loan to a a high-risk borrower when it's clear that they're completely tuned in to their financial situation and are willing to be completely transparent. A specific description like this is nice:
   

   "I am paid bi-weekly and my take home pay is 1067.39 (2134.78 monthly)."

2. Homeownership -- looking at the statistics, homeowners are 25% less likely to make a late payment. If you're torn between lending to two borrowers with similar credit profiles, choose the homeowner or demand a higher interest rate from the non homeowner.
   
3. Asking only for the minimum that they need -- if a borrower is asking for a specific amount for a specific reason, it indicates to me that they're being genuine with their request. If their request states that they're consolidating credit cards and the sum of their balances is $8,200, the closer their request is to $8,200 the better. Asking for "buffer cash" indicates financial irresponsibility in that they're willing to borrow money at a high interest rate just to have cash in the bank...kind of like AIG, just not $85 billion.

Loan characteristics that raise flags:

1. Large loans to people with low income -- Even if you're only investing $50 in someone, consider the amount of the loan that they're requesting. Look at the size of their monthly payment. If someone is unable to pay that amount for three years, your 50 bucks is SOL.
2. Loans to pay for something unexpected that shouldn't have been unexpected -- If someone needs to borrow a relatively small amount for car repairs, it indicates to me that they're completely strapped for cash and are unable to handle the everyday surprises that come about. What's going to happen when the next emergency happens? My wife and I have unexpected costs every month. Last month the car battery needed to be replaced. The month before that, we needed an exterminator. These things happen. If they're stretching themselves to make payments on a three-year loan that covered this month's emergency, what's going to happen when they need to cover next month's?
   
3. Instant funding -- When filling out loan requests, borrowers can select an option that will allow the loan to be "instantly funded" once their requested amount is funded. By selecting this, they forfeit their chances of lenders bidding down their interest rate until the listing's scheduled end date. Borrowers will lock in a higher rate just to have the money a few days sooner. This implies that the borrower is very desperate -- to the point where they are willing to pay a higher interest rate for three years just to have the money faster. According to ericscc.com, a borrow that selects this option will default 32% of the time and is more than twice as likely to default than a borrower that does not choose this option.
4. Current delinquencies -- I don't care very much as much about delinquencies in the past seven years. Current delinquencies are the real kicker. A borrower without any current delinquencies has a 10% chance on being late. As soon as they have one current delinquency, that rate almost doubles to 19%. Do they have eight current delinquencies? Well then that rate will double again to 41%. Many borrowers with lots of delinquencies will say that this loan will bring them into favorable status with those creditors. Be careful. With multiple current delinquencies, you've got up to a 50/50 chance of that person being delinquent with your money.
5. Multiple credit inquiries -- It's normal for people to have a few credit inquiries in the past few months. But you should know that if they're shopping around for a loan for a car or house, credit bureaus will only report one inquiry as long as their shopping doesn't last more than 30 days. If a person says that they have multiple inquiries because they've been shopping for a car or house loan, they're lying...and lying is the biggest flag of all. Once a borrower's recent inquiries hits three, their chances of becoming delinquent on their Prosper.com loan have doubled.

General rules of thumb for lending:

1. Don't invest more money than you can live without for a few years. It isn't like putting money into a savings account where you can take it out in case of an emergency. You don't get your money until the borrower makes their monthly payments.
2. Until you're comfortable with your strategy, don't invest more than the minimum $50 in any loan. There is absolutely no cost for you to diversify, so it doesn't make financial or statistical sense to give anyone more than that.
3. Remember, people can lie in their requests, so make your decision mostly off their credit history. Don't be fooled by people with kids (irrelevant), a high income (unverifiable), or a story about a soon-to-be-successful business (it probably won't be). You never know if they've got gambling debts or a drinking problem. Everyone's going to look their prettiest and say whatever they can to get a loan.
4. Know the lending limits -- loans can be no more than $25,000 and at an interest rate no higher than 35%. Those who are requesting loans at one or both maximums may be extra desperate.
5. Make sure that the distribution of your loans follows a somewhat normal, bell-shaped curve. Settle on a target (or average) credit score that you're comfortable with and center your curve on it. My post from yesterday has some good info on that. Look at my analysis of the average lender and the excellent lender.

I think she's starting to come along...

I'll be out of town for a couple of days starting tonight. I will most likely refrain from posting until Monday. Have a good weekend!