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.