Thursday, May 31, 2007

Prosper Private Lending Service: Do You Want To Be a Collection Agency?

Lazy Man and Money mentioned his tribulations with Prosper.com, a service where individuals buy and lend to each other.

I had looked at Prosper some time ago, and decided not to lend money there at that time for the following reasons:

  • The advertised high interest rates are for the lowest-rated, riskiest borrowers and the forum told tales of defaults so it seemed unlikely to net a significantly high return (lend to 2 people at 25%, 1 of them defaults with the first due date, so you average a loss at -37.5%).
  • You have to win the loan by bidding down against rival lenders so it seemed unlikely to net high rates with the highest-rated, reliable borrowers—yet there is always a chance that even an A-rated borrower might default.
  • To diversify to hedge risk would require many hours of work to bid small amounts to many borrowers (you can lend $50 to a person who is seeking $5,000 in loans from many lenders).
  • Bidding means that you might waste time in research with no result and 0% interest.
I know that some lenders will beat the odds but I suspected that lending at Prosper would require much work, time, management, stress, and risk but with an uninspiring probability that it would not significantly outperform an FDIC-insured 5% Money Market/CD account or moderate-risk stock index fund.

Please share your experience if you have used Prosper or a similar service.

Complete the Prosper motto: "Where people come together to . . ."

Update 6/1/07:

  • Time: 2 timesavers are (1) you can set criteria and Prosper will auto-fund loans from your account, and (2) you are not allowed to be your own collection agency (this means that either the money gets repaid or it doesn't).
  • Rates: Lazy Man's Prosper portfolio (thank you) shows A-grade loans at twice the rate that this Prosper page shows for average A-grade rates, about 20% v. 10% (which means other A-grade loans can be significantly less than 10%).

Update 6/2/07: My Personal Finance Odyssey and The Finance Buff expressed a caution similar to mine.

Update 6/21/07: You cannot cash out whenever you want as you could do with a money market. You cannot cash out early with a penalty as you could do with a CD. You must collect a few dollars per month and wait 3 years (a common loan term) to claim your full profit, if any.

Update 6/23/07: My Personal Finance Blog is pulling out of Prosper. Another point that new Prosper lenders might overlook is that "no defaults yet" after a year does not mean much because you might need 2 years just to get your principal back when I imagine that debtors are getting bored of paying and the luster of their vacation/wedding/business-that-did-not-take-off is long forgotten.

Update 6/25/07: My Money Blog posted data which so far support my 6/23 concern that defaults will increase over time.

Update 6/26/07: How To Measure Prosper Profits Accurately

7 comments:

Lazy Man and Money said...

There are a lot of assumptions here which are not necessarily true.

The biggest myth is that Prosper takes time and/or effort. It takes neither. Money can be transferred from your bank account to Prosper automatically and you can set standing orders that will automatically place bids for you if the numbers match your settings. To beat the odds, you just need to have your settings at high enough rates.

I check my balance at Prosper about once a day, but it's just because I like to see it. Other than that I have no need to login to my account for the next year or ten years.

There are also a lot of loans which are not bid down. These are called auto-funding loans.

Overall things could be a lot of work for very little profit, but they don't have to be. There is an easy, profitable solution if you choose to look into it.

J at IHB and HFF said...

Hello. I thought that I manually would have to allocate thousands of dollars in small $50 increments so the automated method is useful to know, although you relinquish case-by-case discretion and still have to search for the sweet spot (rates not so low that you gives away the store but not so high that your money sits idle too much at 0%--the website states that you have to have money in Prosper BEFORE you can bid).

I noticed that another timesaver is double-edged; you cannot try to collect late payments without risking criminal and civil penalties against yourself, the lender.

I see what you mean about being able to do it with little time. Thank you for the feedback.

Lazy Man and Money said...

Yes, it is that sweet spot that takes a little work to figure out. I recommend the tools at ProProsper.com to help with figuring where that is.

I currently transfer $25 into my account every business day. With my previous loans getting paid off, I find that I typically have some change in my account, usually around $50 because when it gets above $50 my triggers find a new loan.

I estimate that I could probably find 6-10 loans a week in my sweet spot. Since, I'm only putting in enough to fund about 3 loans, there's some room for scale. However, at some point, if I wanted to invest big numbers, I'd probably have to start making bigger than $50 bets. I'm okay with that because at 5 loans a week - 250 loans a year, my account will still be very diversified.

john r. said...

I agree w/lazy man. i have found prosper easy to use - i set up an automatic transfer and have standing orders that place bids for loans with the credit parameters I define.

my returns after defaults look like they will be about 12%, more than bond mutual funds, CDs or money market funds (and many stocks).

J at IHB and HFF said...

Lazy Man, Thank you.

John R.,

Hello. That would put your average return at almost 20% after defaults? I will have to look more for average returns of most lenders. Thank you.

Lazy Man and Money said...

I think John R. was saying that it would 12% after defaults - and that 12% is more than the assets he mentioned. This is different than 12% more than the assets he mentioned. That comma means a lot, I think.

J at IHB and HFF said...

Lazy,

You are correct about the comma that I did not see at first, and thank you for the email too.