The following is my personal review of Prosper.com and my expierences with the site. For those that have not heard of them, Propser.com is a peer-to-peer micro loan lending site. Thousands of individuals that have money get together and make small loans that aggregate into large loans for individuals that need money. The site then manages the anonymous relationship between the mass of micro lenders and the borrower. For this management, they collect a small (1% fee). This fee covers credit checks, running the site, collections, etc.
Most borrowers are looking to consolidate debt, finance a business, payback a friend or lower their existing interest rates. Some have stellar credit (AA on the Prosper scale), with good debt-to-income ratios, no past delinquencies, good credit scores, etc. Others have horrific credit (D, E or HR on the Prosper scale), with recent or current delinquencies, bad credit scores, etc. The rest are somewhere in between (A, B, C on the Prosper scale). The interest rate that each group pays is controlled by Prosper (it this is actually new) and is based on the amount and term of the loan and the borrowers Prosper score. Someone with a score of AA may borrow at 6% (5% + 1% fee), B may be around 10 to 14%, C around 18%, D 25%, E/HR 30% or more. The amounts range from a few thousand to tens of thousands.
On the other side of the equations are the lenders. Most lenders lend the minimum micro amount, which is $25. When you see a loan being funded, there will be literally 100’s of bids of $25 to $50, with only a handful of $100-$1000 bids. The bigger bids seem to come from lending “groups”, or simply people with a lot of money. The reality is the size of the bid doesn’t really matter, as long as it is an appropriately small portion of the total you are investing on Prosper. Diversification is key, because these loans can and do go bad.
I started using Prosper.com in 2009, with an initial investment of $2000. I made a bunch of loans in the $25-$30 range and just let it sit for a year. Overall, things seemed to be going very well and since then, I have raised my investment $2000 ever 6 or so months and now I have $8000 there. To give you an idea of the returns and risks involved I will share my results.
Over the past 3 years I have funded approximately 320 loans. Of these, 18 have been paid in full early, 3 have gone bad and 3 are currently late. The result has been in earnings of approximately $350 and a loss of $70. Total result is $280. If things continue at this rate and I don’t do any additional investments, I expect to make 9-13% on my portfolio of loans over the next 2-3 years. This is actually really good, especially considering that most savings accounts these days may 0.25% and CDs for 2-3 years are only going to get 1.5 to 2%.
In theory, I may recover some of my $70 in charge offs if and when Prosper sells that debt off to a collections agency or is able to recover some of it – but I will consider myself luck if I recover even 25% of it.
Prosper.com is by no means a “get rich quick” system; in fact it is just the opposite. Most loans are 3 to 5 years and unless you are investing hundreds of thousands of dollars with them, you won’t exactly earn a living off the interest. The money you loan via Prosper is not insured and in theory you could lose it all. Prosper.com has also only been around since 200X, and in its time has had to make changes to its model and deal with a few legal and regulatory hurdles.
- Loss Risk – All Prosper.com loans are “unsecured” loans, so just like a credit card of a personally guaranteed loan from the bank. Whether you get paid back or not is based entirely on the credit worthiness of the borrower and their desire / ability to repay the loan.
- Time Risk – Once you place a bid and the money is lent, that money is “locked” and cannot be accessed until the loan is paid back. There is no option for early withdrawal. So if you plan on needing the money you are investing before the term is complete you should look into other options.
- Interest Rate Risk – Just like CDs, since you are locking in rates for 1 to 5 years, there is the risk that interest rates will rise and your capital will under perform.
I am by no means a pro at this, but I will share some of the things I look out for and have learned over the last few years.
- Manual vs. Automated – Prosper.com offers both manual loan-by-loan lending and automated investment plans. I have no experience with the automated plans, but since I like to know exactly where my money is going and why, I have shied away from them.
- Be careful “chasing yield” – Just like the fools that caused the credit crisis, not all borrowers are worthy of credit and sometimes interest rates are high for a reason. While a portfolio of entirely D, E and HR loans will earn you 25-30%, you can expect that at least loss rates to be very high.
- Compare the risk vs. reward. Recently Prosper has started offering AA loans at rates as low as 5% for 3 years. Personally, I think these rates are too low. While diversification is still key and history suggests loans of these types will yield 4%, the risk vs. reward ratio with a 3 year bank CD at 2% doesn’t seem that appropriate. Because these loans are unsecured, I think the 5% rate is too low and as such I have reduced the amount of AA loans I make.
- Read the borrowers post – Do they have lots of typos? Did they even fill it out? Did they explain why they want the loan? Do the reasons make sense? I have seen borrowers looking for $15k no questions asked. On the other hand, I have seen similarly rated borrowers clearly state they need $15k to pay off 2 credit cards with interest rates of as much as 30%. They explain, how the savings in interest will be used to accelerate payments and clearly explain why they believe they are worthy of a loan.
- The money you have sitting in your Prosper.com account that is not invested does not earn any interest. Something to be aware of.
- Keep an eye for Prosper.com sponsored “deals”. Occasionally, where there is an imbalance of loan requests and a dearth of lenders, Prosper will offer rebates of 1-3% of the amount invested to encourage lenders to lender. While this can be a “good deal”, it is not the end all and be all. For example, assume you lend $50 to an E borrower at 30%. Proposer will give you a $0.50 rebate, but you could still loose the base of $49.50 if the borrower never pays the loan back. Not such a great deal.
- Read and understand the borrower’s stats – I have made loans to AA, A, B, C, D and a few E rated borrowers. Regardless, there are a few things that I care about:
- I really don’t like to see existing or previous delinquencies. If there are, I expect a very good explanation. Sometimes people have them, and I will lend them my $25, sometimes they don’t and I won’t lend them anything.
- I don’t like to lend to people that are comply maxed out. If they have 35 credit lines own, are all fully maxed out and debt to income is 97% – I am going to pass. This person is unfortunately maxed out and I don’t want to be the last sucker to lend them some money. I truly believe it is in these peoples best interest to go bankrupt and rebuild. Maybe next time they will living below their means.
- Watch out for dropping credit scores. Not all posts provide this information, but a recent drop in credit score can mean something is going on that the other numbers don’t show.
- Sometimes outstanding credit will be very high (like $300k); this usually is a home-equity loan. I tend to shy away from these, but not always.
- Are they borrowing an appropriate amount of money and at an interest that makes sense? If the person only has $5k in outstanding debt, but wants to borrow $15k – I wonder what the extra $10k is for. If the person has a Prosper score of E and is trying to refinance a credit card with an interest rate of 30% with a Prosper loan at 30%, this doesn’t make any sense. If the roles were reversed, would I want to borrow money at the terms specified, if the answer is “no”, then I have a hard time lending the money.
Overall, I think Prosper.com is great. However, I have not yet tried competing sites like LendingClub.com. I recently recommended them to both my mother and a friend and they both have joined. I personally think that Prosper.com is doing a true service for the country, unlike the leeches in the banking industry. Prosper.com allows people to help one another in a fair and relatively safe manner. Why should I be forced to lend money to a bank at 1%, while they charge my neighbor 30% to pay off his credit card? The truth is that both my neighbor and I would be better off, if I simply lent him the same money at 15%. I make a better return and the neighbor pays less interest.
NOTICE: This article is not to be construed as investment advice. Past performance is not necessarily an indicator of future returns. Investing in Prosper.com may result in the loss money. This information is provided “AS IS”, without warranty and confers no rights.