investing

Person-to-person lending: High return, but risky?

With Prosper you also have the option of lending to individuals or to people who belong to a group. The group may be composed of individuals with no connection to each other except for belonging to the group, or they may be people who work together or have a career in common, such as firefighters. Groups list their outstanding and paid-back loans so you can see their track record. The theory is that members will try harder to pay their loans on time because they don't want to bring down the group's record.

Prosper lists the historical interest rates on funded loans according to credit grade, loan amount and whether the borrower is a member of a group.

Since Prosper is already up and running in the U.S., let's look at some of the things potential lenders can see to help make the decision of whether a particular borrower is a reasonable risk.

Borrower's loan listing at Prosper.com, part 1

This borrower wants $25,000, is willing to pay 19.80% interest and will repay the loan in three years.

Borrower's loan listing at Prosper.com, part 2
Lenders can see that the borrower is a homeowner and he has a bank account. Prosper has assigned him a credit grade of "B" and says that his debt-to-income ratio is 30 percent. This ratio includes current debt (excluding housing) and the full amount of this loan listing.
 

Borrower's loan listing at Prosper.com, part 3

Partial list of bidders. Most are willing to lend the borrower between $50 and $200.

Many borrowers have a clear reason for their willingness to pay 20 percent for a loan when a bank loan is available for less. Generally, it's because they have damaged credit or a very high debt-to-income ratio and can't find funding through the usual channels. But with others it's not so obvious; at least nothing in their description or the information posted by Prosper indicates why they're willing to pay more. Prosper allows registered lenders to contact borrowers through an in-house e-mail system so any questions can be answered.

Prosper assigns a credit grade based on the borrower's credit score at Experian. Prosper's Web site says the credit grade is meant to give lenders a way to measure the likelihood that a borrower will repay a loan based on the borrower's financial history.

Prosper credit grades
Credit gradeCredit scoreExperian historical average default rates by credit grade for borrowers with less than 20 percent debt-to-income ratio
  AverageRange
AA760+0.20%0.00% - 0.40%
A720 - 7590.90%0.70% - 1.10%
B680 - 7191.80%1.60% - 2.10%
C640 - 6793.30%2.90% - 3.70%
D600 - 6396.20%5.40% - 7.20%
E540 - 59910.40%9.10% - 11.80%
HR (high risk)< 54019.10%15.10% - 28.20
NCNo credit scoreCan't estimate default rate for borrowers with no credit history.
Source: Prosper

Prosper also publishes its "marketplace performance" on the Web site. That enables lenders to look at performance and delinquency data across the credit grades.

Keep in mind that, at least with Prosper, the loans are amortized and lenders receive interest and principal on a schedule. If you want to remain a lender at Prosper you'll have to fund your account with new money from time to time.

There are a couple of anonymous blogs that discuss Prosper and may be worthwhile perusing for concerns, complaints or insights of current lenders.

It may be smart to wait until Zopa is online in the U.S. before jumping into the lending business, as there likely will be some significant differences between the two companies. You may find one more to your liking than the other.

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