Prosper.com Person-to-Person Lending Review, Part 1: First Looks

Prosper.com is a person-to-person lending service where you can lend out money to complete strangers. My first and only post about Prosper was back on February 13, 2006, when it was first released to the public. Since then, I haven’t written a peep about them. An online service that offers high interest rates for my cash? Why haven’t I written about them? The simplest answer is that I’ve been waiting for more information to review.

Here is a first look at Prosper from a potential lender perspective.

This is not a short-term, safe investment.

You may have seen this ad, it says something to the effect of “Why settle for 5% APY from banks? Get 15%+ interest from Prosper”. Comparing itself to an online savings account is misleading for a couple of reasons:

Your money is not 100% liquid. The loan term is three years. All loans on Prosper are lent for 3 years. In a bank account, I can just walk over and take my money out. You will gradually get your principal back and might have some pre-payments, but your money is pretty much locked up for the short term.

Your money is now unsecured debt, which carries the possibility of loss of principal. Bank accounts are FDIC-insured. Your Prosper loan is not backed up by anything except for the word of the borrower. The only thing keeping them paying is either a sense of personal responsibility, or the threat of a black mark on their credit report. What happens when their credit is already bad? Will they view Prosper as a serious lender on par with credit card companies? What happens if Prosper goes out of business?

There are a variety of ways you can get higher interest for extra risk. Look at some Canadian Oil Trusts like PGH (15% yield), or high-yielding REIT stocks like LUM (13% yield). I don’t recommend these either, but my point is that you should compare apples to apples.

Prosper is an intermediate-term investment opportunity with lots of inherent risk. In addition, not everyone will get the same results. While one person may get 16% annual return, another person with a similar loan portfolio may have low or even negative returns.

What am I basing my decisions on?

Let’s look at the three major pieces of information you get when you are deciding on which loan to fund:

The Story. This is coming from the cynic inside me, but how accurate are these? I do believe most of them to be truthful, perhaps with a little positive glow on things. But how do I know if it’s not? Do I really need to read “I am very dependable and promise to pay you back”? Some group leaders will vouch for borrowers, but in the end, I put very little weight on this area.

Besides, which is better? The business start-up loan? The “fresh start” loan? The credit card consolidation loan? The I-want-a-new-Lexus loan? Here we might also be mixing emotion and business, which is fine if you want, but I’d personally rather not be emotionally invested in my lending.

Credit Profile. This is actually very useful. In addition to the credit grade which essentially gives you a range for their credit score, you can find out some details on the credit report. These include the number of delinquent accounts, how much was delinquent, negative public records, and their current revolving credit balance. More information here.

Employment Data. This includes both whether they are employed or not, how long they’ve been employed, and their income. This gives you their current debt-to-income ratio. Again, this is all self-reported by the borrower. I believe it would be far too costly for Prosper to actually verify this data, but it would be nice.

Of course, Prosper says that it is a crime to lie on a lending application, but my question is how many people have they caught and prosecuted for this crime? My guess is zero. In June 2006, in response to this criticism they started performing spot-checks for the “identity, address and income of a select number of borrowers.” They do not release the frequency or passing rate of these checks. Therefore, I also put relatively little weight on this area. I treat it like a very rough estimate.

In the end, all I am comfortable relying upon is the credit report, just like the credit card companies. I think the card companies are pretty good at what they do, so the only way us individuals are going to make money is to be satisfied with thinner margins than them (lend at cheaper rates), while at the same time trying to achieve close the same level of diversification.

Is this possible? Is it worth the effort needed? Check out Part 2, where I dig into the numbers.

Comments

  1. Seems as though it has that potential, if perhaps some of the areas mentioned above could be verified. Is there a minimum required to start with Prosper?

  2. You can start lending with as little as $50.

    There is definitely potential to this idea, it’ll be interesting to see where it goes. They’ve only been around a year, and they have already made some improvements.

  3. I’m assuming the money that is ‘invested’ into this is reported as income to the Government. Which means that a simple $50 wouldn’t be very much worth it to get started. Perhaps a few thousand dollars? That’s a big risk.

  4. Lender Taxes. Interest income is taxable and reported on 1099.

    To get proper diversification, you’ll definitely need to lend more than $50. Most definitely risk involved.

  5. I agree completely with your views and opinions about Prosper. I’d rather put my money elsewhere with less risk. Not to mention, I am all for people being debt free and I feel Prosper just makes it easier for people to be put into more debt. Obviously, if they really wanted a loan, why would they go on here? Probably because banks/CU’s/CC companies denied them, making them an automatic high risk in my book.

  6. Jonathan,

    Yes, it’s risky, but OMG is it fun!

    I’m about as Vanguard-diehard-esque as any of your readers, and truth be told my long-term AAP looks a lot like yours (but with perhaps less value-tilt). But I still have a little fun money, and most of that is in Prosper.

    My other fun, non-diehard money is:

    (1) $800 in a penny stock that keeps fluctuating between 7/10 of a penny and $01.5. This no longer excites me, and I plan to sell in April once the gains become long-term, and contribute the proceeds to the low-cost funds in my AAP.

    (2) About the same amount in a major mining company stock. Earlier in my AAP planning, I regretted not being able to fit Vanguard’s Precious Metals into my portfolio, and thought this would be a valid substitute. I’ve since decided my AAP is fine without it. I plan to sell this as well and add my long-term funds.

    Prosper is by far the most entertaining money I’ve invested. No doubt many of the stories are BS, but I pay more attention to the credit report summary and mostly read the stories for (1) entertainment and (2) getting an idea of how seriously the borrower is taking the loan application. You’d really be surprised what some people are trying to borrow money for. But it feels good to help out the ones who seem to have a real plan for paying off higher-rate debt.

    I started Prosper right after your first post about it, and have invested in over 130 loans so far. I’ve had one default and five more that are so late I have to assume they’ll eventually default. All of these are from the 30 or so I bid $50 on in the first two months, back before Prosper provided as complete credit data as they do now. The rest of my loans are all paid as agreed (so far).

    I’ve also used Prosper to loan money to a friend who’s had a heck of a time getting out of her 20-something credit card hangover. She was on the right track, just was paying such high interest she couldn’t pay it down very quickly. I would never loan even a trusted friend a few thousand without an infrastructure like what that website provides. Hypothetically, if she were to go deliquent (which I feel CERTAIN wouldn’t happen – she’s been listening to my lectures on finances for years!), her credit would be ruined.

    Another attraction: second to your blog, Jonathan, the forums over there have been the most educational online resource I’ve found for personal finance and investing. But there’s a little more soap opera effect over there – especially when some of the more resourceful lenders investigate borrowers whose motives are suspect. If you’ve got some time to kill, try a search on the Prosper forums for a borrower named “JessM” and you’ll see how entertaining it can get.

    No way I’d argue that people should consider investing there. But it is a great “fun money” investment where you can (cheaply) knock off any urge for active investing, while your real money is in more traditional funds. I think someone on the forums called it “Vegas, without the drinks.”

  7. I am not shrilled with Prosper either and probably never will. 18% annual return? Big deal! And three years is too long. In my opinion, the risk involved requires much higher return than 18%. Besides, I also feel that a large amount of money is needed to really earn any meaningful returns. But, on the other hand, are there many people willing to put more than $10K in Prosper? I found this on another blog (RateLadder): $40,883,918.00 for 7960 loans from 29899 lenders. That’s about $1374 per lender on average. I don’t see any serious money can be made with $1374. And as you said, all the information are self-reported and there’s no guarantee the accuracy.

  8. Jonathan,

    Not to hijack your blog or anything (if I already haven’t, sorry about that…) but in response to:

    “Prosper says that it is a crime to lie on a lending application, but my question is how many people have they caught and prosecuted for this crime? My guess is zero. Therefore, I also put very little weight on this area.”

    I have no idea about actual prosecutions, but Prosper loans have a verification process they go through after the bidding is over. I have had many loans fail verification, with my bid returned to me.

  9. I have been lending on Prosper since last August. So far, 12 loans, no default, 8.71% interest after Prosper fees. I have been very conservative in lending. Initially, I only lend to AA people with stories that I can somewhat verify. Now my strategy has shifted. There is a particular group leader that I trust. So I only bid on a subset of their loans. We will see how successful that is. Overall, Prosper is entertaining, but not an efficient use of my time for investment.

  10. I’ve been on prosper for three months, and have a portfolio of about 30 loans…The site has positive and negatives…As to your post, they do verify addresses and pay stubs, so many loans that fun are never orgininated because the lender can’t provide documents to verify his listing;

    I think that posper has the long term positibility to be delivering returns somewhere between 7-12 percent, depending on the skill and luck of the lender and the site’s own devotion to the business model. One of the difficult things is now the wait time when the hold your money (say a few days to finish an acution you bid on, and a week to verify it), you get no interest for significant chunks.

    In the long run, the consumer lending market may be a good low-correlated investing avenue. It’s too early to tell now, but don’t discount it outright. Proper yield comparisons would not be to oil trusts or reits, it would be to its competitors (like zopa.com) or junk bonds.

    You never know, you might post again in a year or two and say you were wrong, and that it’s a good fixed income diversifyer.

  11. SeattleHawk says:

    Hi Johnathan
    I dont have any investment in REITs. I intend to invest some money in them. What is your opinion on investing in REITs at this time and which ones would you recommend if one were to invest in them soon.

    Thanks

  12. Wisely Sunshine says:

    I’m so glad that you talk about Prosper. I’ve been trying to do a research about it. I’ll definitely check back and see what your readers talk about this investment choice.

  13. Jonathan,

    Thanks for posting this!
    Reading this blog has made me at least a few hundred dollars so far! I’m at a point now where reading your thoughts on a particular enterprise is crucial to my decision-making concerning it. I really appreciate your taking the time to post the stuff you post, a lot of which is clearly related to readers’ curiosities.

  14. arainydayman says:

    I’ve been a sup-prime underwriter for 2 1\2 years. I had to base alot of the same decisions based on the limited information that Prosper gives.

    Just as any investment, I believe if you have guidelines and expertise about the subject, you can get justified returns.

    Also there’s rumors that Prosper will create a secondary market to liquify part or your full portfolio to another lender

  15. So far, I guess I’ve been a bit negative, but I’m trying to keep it fair. Just because something has risk, and the main thing you have to judge that risk with is credit history, doesn’t mean it’s necessarily a bad investment. Credit card companies have been doing it profitably for years. I’m just pointing out what I think are important aspects to consider.

    While the income is self-reported, Prosper also states that it “requests further verification of the identity, address and income of a select number of borrowers.” I have no idea what % of borrowers get audited, or if they verify all or part of this information for everyone.

  16. So glad you’re discussing Prosper and it’s business model. I am invested in the site and 1 year into it, I’m mixed in my thoughts about it. There seem to be decent return for those that chose to invest in it.

    I am concerned about the apparent shortcomings that I would like to see resolved. I have accepted the risk level and am not blind about that, but it does seem effortless for some individuals to shirk their loan responsibilities. I would like to see a sweep type of transfer of my money out of prosper on a daily/weekly basis. Also not getting a rate of return on my held as cash @ prosper.com perturbs me. If paypal can do it, why can’t prosper? Another point I would like addressed is the actual interest you would gain from investing X dollars into a loan for the 3 years/36 months. Unfortunately, it is not a simple interest rate of return, but one of diminishing return.

    Prosper seems very ‘beta’ right now. I wish Zopa would make well on their promise to open in the U.S. in the fall of 06, which has come and gone without a whimper, maybe then prosper would rachet things up a bit for the better.

    Given these shortcomings, I’m anticipating greater changes or in 2 years, I’ll just have my money FINALLY pulled out of this interesting idea.

  17. Avid Reader says:

    I’ve been on prosper for a couple of months now and have a few loans out there. The only thing I can say about this is that you cannot see this as a serious investment vehicle – I use my Las Vegas fund (money I would’ve gambled away during CES or SEMA) on prosper. If I get some good returns, great. If I lose everything, it would’ve been lost in the first place anyways to Vegas.

    As always, be very careful with your own money, but there is definitely a fun factor to prosper that lasts longer than black jack or the slots.

  18. Dan – Vegas without the free drinks?! I don’t know about that. :)

  19. Note that you have to transfer at LEAST $100 at a time, so the minimum investment is definately not $50. Also, there is the time with the money (sub $100) sitting there earning NO interest, unless you keep transferring in enough to allow the transfer out, it’s just going to sit there.

    But my feeling on the matter is that it’s ‘fun money’. Everyone has their hobbies, everyone spends some money on things that excite them. I personally have resolved to put some ‘fun money’ in here and have a little fun while trying to see if I can keep my money and possibly earn some. Legalized online gambling in my oppinion. I get the same ‘high’ from watching to see if the payments go through as I would pulling the handle on a one armed bandit. I also enjoy reading the listings and have found a group leader that actually seems to really check into these people, so I feel a bit more comfortable.

  20. This is DEFINITELY sub-prime lending for the most part based on the stories I’ve read on the site. If I were to invest via Prosper I could see myself doing ‘standing orders’ for $50 and investing in only AA and A credit grade loans. Othewise, you could spend a lot of time scrutinzining all the loan requests in order to make bids for loan requests you thought were worthy of your funding.

    Jonathon,
    From some of the stories on this site (90% of which seem to be about people up to their eyeballs in credit cards debt), these people need a good blog on reducing credit card debt and staying out of credit card debt. :-)

  21. Melvin: Need to correct you there, sorry. Transfer minimum is $25, done it several times. Bid minimum is most definitely $50, just look at any lender’s portfolio on lendingstats.com. But I agree completely on your “fun money” statement – and it’s great that you can get that “high” from receiving (or losing) a $1.87 payment each month while your real money’s invested with no high in mind in Vanguard.

    mc: It’s sub-prime only if that’s what the lender decides to invest in. Or a lender can bid only on AA loans (760 or above) if that’s what they want. Or, one can chose to passively invest only in loans B and above with no delinquencies or public records by setting up a standing order if (s)he chooses.

    Jonathan – My lending record would probably be FAR worse if they did provide the drinks!

  22. Let me second the call for fun money. This is essentially gambling on an idea. I really liked the idea behind the site, and I use my money to fund people who get stuck with ridiculous payday loans. I only invest in very high-risk, high-interest debt. (Which is exactly what they say NOT to do, but is this for fun or not?) My results? I have $1000 invested at an average rate of 25%. So far, 1/4 of my borrowers are on the way to default, so I guess I’m breaking even. I reinvest my payments back into the site, but I won’t be investing more. I like the fact that I’m investing money in people who really need the help, and 3/4 of them ARE paying the money back. (And I can deduce the bad loans next year as bad debt.) So I’m perfectly ok with it.

  23. I find that people who are overly skeptical (Sun, who commented above comes to mind) haven’t spent any time really evaluating it. Prosper has some issues, but by in large, they are doing a lot of stuff right. I have $3000 loaned at about 16% return with all current loans. Prosper has risk, but so does every investment returning 16%. I challenge those who like “safer” investments than prosper to find a less risky 16% return investment (and not only in a bull market).

    …and I wholeheartedly agree that propser is one heck of a fun investment. My advice: don’t believe any borrower stories and go strictly by the numbers.

  24. You do not have enough knowledge about Prosper. You make assumption that are not based on facts

  25. I’ve been a lender on Prosper for about a year, and in the past year I’ve earned over 20%. My goal was to earn 13%, and I thought if I earned 15%, it would be gravy. I’ve had 1 default and 1 early payoff, and I don’t even consider applicants with lower than C credit.

    I viewed Proper.com as a chance to get into the sub-prime market for next to nothing, and that’s exactly what it’s been. I really don’t pay a lot of attention to the ‘story’ of an applicant. Just show me their credit score, their DTI, the past history, and then I’ll peruse the ‘story’. I just think of the story as a complete lie that gives some minor insight. Quite frankly, if you have a person with 5% DTI and AA credit score whose never missed a payment, do you really care what the story is? I’m just like a bank, I look at their ability to repay the loan regardless of the purpose.

  26. Prosper.com is very misleading to those that are in need of a loan. It is a hyped up joke. If you are really in need of a loan, I am warning those that need help, you are wasting your time at PROSPER. You need to go elsewhere if you really need help or get a second job you will be alot better off. This site is purely a joke.

  27. frequencydip says:

    @susan

    Lenders are not on prosper just to ‘help’ borrowers. lenders are on prosper.com to help borrowers who will pay the loan back. This isn’t a charity. Lenders have no way to look at you and see your future, we can only judge you by your past, so if you have a bad credit history we will likely assume your credit future will also be poor..

  28. First, I have a basic economic thought: I believe as a diversification tool and risk-free rate of return investment (if spreading out your loans thinly enough, you can achieve the avg loan rate net of defaults as posted at prosper) of 9%+, smart investors will pile in within the next year or two driving up demand for loans (and hence agressively decreasing the average interest rate since lender supply outstrips borrower demand). Therefore, I’m investigating and loading up on 3-year lockins now. Anyone else feel this way? Here is the latest on my experience:

    I?ve been using prosper for a few months now and I?m quite pleased with the results. I have over 20 loans out with an avg rate of over 13%. All loans that have existed for a few weeks are current with their payments. I?ve posted on top groups and strategies for those interested at my blog. There are groups to avoid and strategies to employ to weed out the bad apples. Good luck!

  29. The support is terrible. It really sucks.
    No one answers support phone line – you can only leave a message.
    They haven’t replied to my last two support request for 3 days.
    I have been trying, unsuccessfully, to transfer funds back out of Prosper for 3 weeks now. I need their support badly, but I can do nothing but wait. After this I want to have nothing to do with Prosper. But I still have to wait 3 years to get back the $200 that I loaned.

  30. I have 45 loans, and stopped putting money in. After a year I have 6 in default. Some of my defaults are B and C grades. Thsi was not expected.

  31. I just signed up for prosper last week as a prospective borrower. After giving my personal information, (ie. soc., drivers license number, and bank account information) I was prompted to ask a few questions pertaining to my credit report. The questions were worded in a way that made them rather hard to answer. Like one referenced a loan I had a few years ago as an auto loan when it was a unsecured loan through my bank. In any case, my account wasn’t verified and I was then instructed to fax photocopies of personal information to a fax number given to me online. I stopped right there. Furthermore, when I tried to phone customer service during normal business hours I received no reply. Lacking customer service combined with sketchy information requests really makes me question the legitimacy of this business….

  32. I can make this real easy……I have 30G’s in school loans, I’ll offer anyone on here 7percent off the books interest until its paid off. Send me an offer…………..

  33. ReVeLaTeD says:

    I’ll have a fairly large sum of money coming to me within the next month. I’ve already done the math and plan to have quite a bit left over after paying off all of my existing debts and making some stacked CDs for some interest income. I want to get involved in Prosper. I already know what kind of lender I intend to be – HR/E/D/C with high income and low DTI – basically, people who are just like me, hard working individuals who make a lot of money, but made bad choices in the past. I don’t feel it justified to hold that over them, especially if it’s like a Chapter 13 BK where payments ARE being made on time and diligently. I care more about diligence now, than the fact that when you were a 19 year old kid you didn’t pay that Macy’s bill. Why lend to A/AA just because their credit is stellar, when they could just as easily walk into their local credit union and get not only a larger loan, but one at a substantially better rate? For me that’s a red flag – why are they on Prosper?

    I’ve tried to do research, but there’s not a site out there that gives me the data I need. I don’t care about percentages of ROI, I don’t care about default curves, I don’t even really care about ratio of credit risk to repayment assurance. I care about two things:

    - What is the minimum amount of money necessary to receive a ” worthwhile amount of money back, both in a diversified ($50 to 10 borrowers, for example) or consolidated ($500 to one borrower, for example) portfolio?

    - Using REAL statistics, how much recurrent income are people making from the site? In other words, what is the income potential?

    No percentages, just dollars, because quite frankly I’ll derive my own percentages based off of actual dollar amounts which is what my brain requires to make a decision that works for me. I don’t care about the initial churn. I’ll have plenty of money saved, plus the CDs which will assure me some regular income once those are set up, and I have a great paying job, so money isn’t an object. But it would be nice to get into some basic investing.

    My long term goal – to end up with at least $1000 in monthly income.

  34. I have not had too much of a problem. i have 51 loans, 50$ each. One loan just went into default this month, having had already paid 6 payments, so i am at risk in loosing $40. But for the last 18 months, i have made a 16% average return. A majority of my profile is C grades.

  35. Prosper, filed to go public today. ……………………..

    I have 46 loans and I did not invest correctly. I have 13 defaults. Prosper is an marketplace. That is all. The investor better know what they are doing. Just like the stock market. My avg interest rate is 24%.

  36. Prosper seems to be a viable alternative to higher interest rate personal loans and credit cards. And, lenders stand a chance to earn a nice rate of return on their investment.

  37. Prosper lets the little guy get a taste of being a big credit card company. They have informative how-to lend successfully on their site and even have portfolio plans to do it for you. DANGER DANGER!! Never trust anyone with your financial management!! HELLO!!! MADOFF!!!.

    That being said, I have made a reasonable return on Prosper. 51 loans out, two in collections, one on the way. Avg. return 12.31 percent and that’s on only AA and A borrowers. The lockdown of 3 years is not too sexy and this is not an FDIC insured product, which means a lot more to me now post bank collapse than it did when I put my money in a year ago. I agree with the funny money sentiment.

    Sky Minor the lender is meh about prosper.

  38. EKWoodard says:

    I am a college student, with many business ideas. I have seen others prosper from business ideas I had but did not have the income to fund. I was told about Prosper as a possible way to find investment funds. I was more interested in a partner or partners with investment capital. I have fair credit but many unpaid medical bills. I have a defaulted credit card five or six years ago. I haven’t been late with a car payment on any of my car loans. I haven’t been late on any of my signature or payday loan payments. As a student I have a high debt to income ratio. I only work part time and have a low income. Any ideas where I could look to find someone willing to look at some of my ideas and see if they might be interested?

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