Prosper.com Continued – Can you earn a living using Prosper.com?

I noticed that several people found my last post by searching for “Can you earn a living using Prosper.com”.  I didn’t exactly answer this question in my last post and thought I would give it a go.

The answer isn’t really Prosper.com specific, as much as it is a question of what income you need to live on and what rate of return you can get?  Prosper certainly provides the opportunity for you to earn rates of 5 to 30%, but the default rates increase as the rates and credit worthiness of the borrowers go down.  If I were to truly try to live off the interested earned via Prosper, I would be conservative and plan on getting only a 9% return using a well diversified portfolio of loans.

Before we start, let me explain the basic mechanics of how this works:

  1. You need up front capital to invest.
  2. You loan the money out for 1,3 or 5 years.
  3. The borrower pays you your principal and interest monthly, with the the interest front loaded like any standard loan.
  4. The money is deposited into your Prosper.com account.  If you needed this money to live on, you would have to withdrawal funds monthly.

Now, let us breakdown the numbers and see if we could actually earn a modest living using Prosper.com only.

Let’s assume the following:

  • You have a $250k nest egg to invest
  • You invest in a well diversified portfolio of loans that average 9% return (including defaults)
  • You invest all the money up front on day one (hard to do by the way)
  • All loans are for 3 years
  • Monthly you leave the principal in your account and only withdrawal the interest to live on – thus “earning a living”

In this case, you would roughly earn the following in interest:

  • Year 1 – $19,416 in interest
  • Year 2 – $12,289 in interest
  • Year 3 – $4,492 in interest

Obviously, even if you lived a modest life and had your car and home paid off, trying to live on an average of $12,000 a year would be a bit tight.  If we up the initial investment to $500k we get the following:

  • Year 1 – $38,833 in interest
  • Year 2 – $24,577 in interest
  • Year 3 – $8,985 in interest 

This is clearly better and yields you an average income of $24,000 a year.  Of course after taxes you would only end up with about $20k.

In both scenarios, we have not spent our original investment.  This is key, because that is the capital on which you will want to re-invest to sustain your earnings into the future.

If this is truly going to be your only source of income, you will probably want to reinvest the principal each month.  This effectively makes you on the lending end of an interest only loan, as the principal is continually re-loaned back out using the same 9% return / 3 year / full diversified plan.  Theoretically this means that your interest earnings will not drop over time and instead will remain consistent.  The results would then be:

  • $250k starting investment
    • Year 1 – $22,500 in interest
    • Year 2 – $22,500 in interest
    • Year 3 – $22,500 in interest
  • $500k starting investment
    • Year 1 – $45,000 in interest
    • Year 2 – $45,000 in interest
    • Year 3 – $45,000 in interest

This brings us into the range of a salary one could more comfortably live on.

While that seems all fine and dandy, there are most definitely risks.  Here are just some of them:

  1. This assumes you have $250k or $500k just sitting around and you can make the initial investment
  2. Putting all your eggs in one basket (Prosper.com) is a risk in and of it itself.  Prosper.com could go under, be forced to restructure, who knows.
  3. The economy could go in the tank and loan defaults could spike.  This happened to Prosper back in 2006 with large amounts of loans going into default.  The result was that on average you might only see returns of 4% or potentially even slightly negative.  If this is your only source of income you would find yourself in a tough spot.
  4. Interest rates may drop in the future.  Prosper interest rates have dropped at least once since I have been using the service.  So your future returns may not be as good as 9%.
  5. Each month you will need to reinvest approximately $6k or $12k into new loans.  There is a very real risk that there may not be enough borrowers with the terms, rates and credit scores you need to maintain your 9% average rate, level of default and diversification requirements.  If you are not able to fully reinvest into an ideal new set of loans, you will see slippage in your monthly income.
  6. Add to these risks, all the other risks I listed in my previous post.

In closing, I think the answer is “yes you can earn a living using Prosper.com” – but this is based on a number of risks and a large number of assumptions.  It is nice that the rates of return of Prosper would at least allow you to entertain the idea of earning a living, with banks only offer 1-3% for 1 to 7 year CDs, earning a similar amount of interest to live on would require a signifcantly large amount of initial capital (Think $2M+).

Cheers,

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.

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