A reader named Jo left an interesting comment in response to my recent Lending Club update. As it turns out, Jo has been involved in peer lending (via Prosper as opposed to Lending Club), albeit as a borrower instead of an investor/lender.
According to Jo:
What you guys (lenders) do for us who are in desperate need of loans is a fortuitous favor. Speaking for myself, I am unable to get a loan the conventional way. For this, I am thankful.
I hope things continue to go well for you, and that those who owe you will pay you back in a responsible manner. If not, this will cause many potential lenders to shy away from this method of investing as part of their portfolio.
I, too, hope that things continue to go well. 🙂
From the lender’s perspective, there is definitely a nice “feel good” component to peer lending. That being said, it’s still important to remember that this is a business transaction. If you get too attached to the idea that you’re helping people out, you might get burned.
If you want the “feel good” aspect, look at http://www.kiva.org instead — microlending at no interest to help people in less-fortunate areas of the world expand their businesses. In my (admittedly small) collection of Kiva loans, I’ve never had a late payment or a default. Their reported average is that 2% of loans go late, and 1% default.
You don’t make any money, and it’s not tax deductible. But if you want to feel good about your loans, this is the place to do it.
Performance statistics related to Prosper suggest a relatively straight line, meaning that loans continue to default at close to the same rate throughout the entire 36 month loan cycle. It does NOT flatten out at any point in the cycle. More than 40% of all loans funded via Prosper have defaulted.
Joshua,
Yeah, you are absolutely right about the APR on a bridge loan being less of a big deal. Unfortunately, my experience with Prosper was that it was filled with many people who were willing to tell a prospective lender what they wanted to hear… truth or not. Prosper made it clear to lenders that they didn’t feel that the narrative portion of the loan application was a material part of the lending process, and therefore, borrowers could lie out of the side of their teeth with no repercussions. So basically, a borrower could tell me that it would be a short term loan, but there is no mechanism to enforce that. (It gets more difficult with automated bidding, too.)
(One complicating factor with short-term loans is exactly as you described — the higher APR’s don’t “hurt” that much. As a lender, early paybacks cut into my returns because turning my investment funds over more frequently decreases the time that they are at work, lowering my total profits. So I desire a higher APR to compensate for that.)
Entrepreneurs can pose a challenge as well — there are many instances on Prosper where the business failed, and along with it, went the loan money. So there’s an added risk factor. (Starts-ups have high rates of initial failure.)
WRT those people who are getting rate jacked left and right, it brings up memories of my early days at Prosper. Back then, lenders would say, “Why would I lend money for debt consolidation? Anybody and everybody can get a 0% balance transfer for a year, and keep turning it over.” I used to be the lone wolf, and side with borrowers. At the prime grades, there is definitely some value in locking in a fixed single digit interest rate.
I do hope Lending Club makes it easier for lenders to turn a good profit with little effort. In the P2P arena, it is clear that Prosper is not that place. And even now, it is still difficult to separate luck from skill when looking at the returns of the best lenders. (It’s no different than picking 5 stocks and claiming the returns aren’t matching the average market returns. Of course they won’t.)
Dan –
You made some good points. 31% is quite high, and doesnt seem as though its a good situation for a loan to be kept to term. That being said, there are still some good reasons to move forward.
On a monthly basis I speak with 100’s of entrepreneurs. I would venture to say that at a minimum 65% of them are seeking capital, 40% of which are in need of small bridge loans. Right now that is mostly to stock up on holiday inventory. If a business owner takes out a $10,000 loan for a 4 month period, they really arent hit hard by the apr, even at 31%. This is also the case when they may be able to get a significant discount for a bulk purchase.
It can also make sense to take out a high apr loan when consolidating credit. These days a record number of people are receiving those wonderful “your APR is going up for no good reason” letters from their credit card companies. Obviously, when this occurs the min payment goes through the roof and those payments will be due for a VERY long time. Taking out a fixed-rate installment loan is a very attractive option to get out of this revolving door pitfall.
My personal philosophy is to stick with small loan amounts when they have higher risk credit profiles. At least in that case they will have a fairly small minimum payment to make. ($1,000 @ 34% = $45/mo)
As a lender I love prosper, I ran into defaults early on (2007ish), but since it came back to NY I am current on nearly 15 loans.
Like Dan hinted at, I find people that are current with their debts but are looking to consolidate. This way I know they can do it at the higher rate, why not give them a lower one?
Dan: I agree that there are likely to be more bumps in the road, and I’m really not sure where things will wind up. One thing that I *do* know is that risk and reward are intrinsically linked, and to think that the rules have been rewritten in the peer lending world would be foolish.
One interesting point that is supposed to be covered in LC’s upcoming webinar is that most defaults happen between 6-18 months, with average portfolio returns rising after that point. Here’s the link for those that are interested:
http://blog.lendingclub.com/2009/12/07/upcoming-webcast-the-borrower-repayment-curve/
Nickel,
Sorry I jump all over your P2P posts, but having some, uh, experience with the issue, I always love to share my experience with those who will listen.
This being a personal finance website and all, the first thing I have always asked myself when lending money on Prosper is “When is it a good idea to *borrow* money at high rates?” (The follow up thought is, if it’s a bad idea, it’s a bad business transaction, and the lender will get burned. Unlike the subprime mortgage mess where the lenders sold the cash flow and the associated liability/risk, Prosper lenders are stuck with the loan AND the liability.)
In Jo’s case, she borrowed her latest loan at an astonishingly high rate of 31%. With the servicing and origination fees, her APR is 33.39%. Ouch! If she is so willing (desperate?) to borrow at such high rates, just how tight are her finances? How can I have reasonable confidence that she can hold it together for 36 months? If the professionals won’t lend her money at any rate, why should we? We’re amateurs. The professionals, that is, the banks, can smell money a mile away… if there’s a buck to be made, they’ll sniff it out. If they’re going to pass, why should we take it up? Remember, we’re amateurs, with nary a clue as to how to do this right.
Jo’s second loan presents an interesting case. She’s right when she says that her first loan was paid off early. But Prosper shows a financial snapshot of her at each listing — and I can compare the “before” and the “after.” Since her first listing, her DTI has doubled, and her card utilization has skyrocketed… yet she has a higher reported income.
And least we need more warning, Prosper says that loans with similar characteristics have a loss rate of 14.9%. Ouch.
At Prosper, we found out the hard way that those that can’t borrow from traditional lenders have no qualms about screwing over the average Joe who lent money to them. Prosper has long since gravitated away from the “anybody can borrower, regardless of credit” model, and I think Lending Club learned a lot from the early Prosper experience — their minimum standards, although far from high, do screen out the crappiest of crappy borrowers. In fact, IMHO, they’re actually pretty decent. It’s also why in a few years, I’m waiting to see just how well a Lending Club lender does — I do not believe that returns at 6 months are sustainable — but I would like to see if net LC returns can beat those of a CD in the long run.