Saturday, June 30, 2007

Prosper lenders avoid high risk loans

Earlier this week I put together a list of all the top Prosper blogs. As I was reading, I came across an interesting post from January on Money Walks. The article, Blame the Lenders? Or the Borrowers?, showed that high risk and E-grade loans made up a full 80% of the listings at the time. Money Walks also discovered that lenders were allocating nearly 50% of funds to those risky credit grades. This surprised me and I decided to take a quick look at current open loans.

At the time of this writing there are 2554 open loans. 48% are high risk and 19% are E-grade. A full 67% of loan requests are from these risky credit grades - not quite as high as earlier this year but still very high.

So, are lenders funding these loans? Of the open loans I ran a quick search to see which ones have already been funded at least 75%. Only 8 of 1221 open high risk loans (<1%) are on their way to funding. Not much better for E-grade - 6 of 476 (also 1%). How about AA and A credit grades? 18 of 67 (27%) of open AA loans are at least 75% funded while 13 of 67 (19%) A loans meet the criteria. It appears that lenders have learned their lessons over the past months and are now avoiding high risk borrowers. The money is now flowing to those with good credit. Of course, many of these loans I looked at have just opened so the percentage is not representative of how many will be funded by the time the bidding closes. It does, however, allow us to compare the different credit grades.

The graph above shows the number of loans that are at least 75% funded compared to the number of open loans for that credit grade. Last week Matt explained why it makes good financial sense for some people to borrow from Prosper. Those with good credit and no home to borrow against can usually get a better rate through Prosper on an unsecure personal loan than they can through a traditional bank. It appears, however, that this demographic may be a very small minority on Prosper. Many of those seeking Prosper loans may be borrowers that can not obtain financing through other means. Many months ago, lenders on Prosper may have funded these loans but high default rates have caused changes to investing/lending habits.

It's also interesting to note the size of loans being funded to high risk borrowers. Of the 87 open listings that are at least 75% funded only 4 of them are over $20,000 - all to AA and A borrowers. The largest funded loan to a HR borrower is $10,000 (which one lender put up the full amount despite never bidding on anything but B or better in 58 previous loans - very odd.) Bottom line, if you want to be funded on Prosper today and especially if you want to borrow more than a couple thousand dollars, your chances are pretty slim if you are a high credit risk. It appears lenders have changed their investment patterns in accordance with good risk management tactics.

I realize that more complete statistical analysis can be done on closed loans and perhaps I will do that in a future post. It will be interesting to look at which credit grades have been favored by lenders over time.

Thursday, June 28, 2007

What effect would a recession have on the Prosper marketplace?

In the financial news you can find a story almost every day about the weakness in real estate markets, rising foreclosure rates, and increases in the number of bankruptcy filings. Some economists worry about the effects spreading across the broader economy and triggering a recession. The bearish outlook suggests that lenders will tighten up their borrowing criteria, consumer spending will decrease, and unemployment will start to increase. FX Street lists 6 historical indicators that suggest we may be heading for a recession (all of which have now occurred):
  1. When GDP growth was below 3% annualized for 5 consecutive quarters.
  2. When the Fed tightened monetary policy (8 of the last 10 times).
  3. When the yield curve was inverted (6 of the last 7 times).
  4. When the Conference Board Leading Indicators were 0.5% or more below a year earlier (9 of the last 10 times).
  5. When new building permits were 25% or more below a year earlier (7 of the last 9 times).
  6. When payroll employment growth dropped to 1.4% over a year earlier.

Other economists are more optimistic and suggest that the sub-prime fallout won't spread, and we will continue to see the economy improve and move ahead.

The truth is that economists have never been good at predicting short term moves in the economy, but history does show cycles of booms and busts (or expansions and recessions). During a recession you will see a significant increase in the number of defaults among the lower credit grades. The following is a graph of historical default rates for speculative and investment grade loans.

From the above graph you can see that during the 1990-1991 recession there was a significant spike in default rates. In addition, most other asset classes don't do very well in a recession. In 1990 the S&P returned -3.11%, the Russell 2000 was at -19.48%, the US housing market showed a decline, and the junk bond market took a hit as default rates rose. In fact it is because of the 1990-91 recession that rates on junk bonds are so much higher than rates on better classes of bonds. When a recession hits it is likely that it will be accompanied by higher default rates on all types of debt including Prosper loans. If past recessions are a guide, the increase in default rates will be much more profound among sub-prime and lower credit grades.

So, what is the best way to protect against this potential risk?

First, make sure that you have the appropriate time frame outlook for your investments. At Prosper, your minimum time horizon is 3 years since all loans originate based on a three year term. I would suggest that your time horizon should be longer than that. If you have 20+ year time horizon then your returns are going to approach the market average. The long term average for the stock market is about 10%. For the bond market it is about 5%. We don't have good numbers for Prosper's long term average over cycles that include bull and bear markets, but I would guess that the long term performance for a portfolio of above prime loans would fall somewhere between the 5% bond market return and the 10% stock market return.

If you have a shorter time horizon, for example, if you absolutely needed the money in 3 years then you could end up taking a loss or smaller return on your investment. Think what would happen if you invested in the stock market before 9/11 and then took your money out 3 years later. Given enough time, however, the markets recover from downward cycles and investments return to their long-term historical rates of return (in economic terms this is called regression to the mean). The same is true for Prosper; with a short time horizon you could end up with less than the long-term expected rate of return if your investment horizon overlaps with an economic recession. With a longer time horizon, the recessions will have a small overall effect on the portfolio as they are balanced out by better years.

To further protect your portfolio from economic downturns, you can consolidate your loans into better credit grades and spread your risk out across a variety of loans as I discussed in my risk management article. If, for example, you loan primarily to homeowners or real estate investors than your portfolio will be more exposed to a real estate downturn than if you have a wider variety of loans. Focusing on the higher credit grades help, since historically it is the sub-prime loans that are least able to weather an economic downturn.

Lastly, don't put all of your investment money into any one asset class. You should start with an emergency fund in something like a money market or savings account that can be easily accessed if needed for an emergency. Then any remaining money can be diversified among several different asset classes - stocks, bonds, real estate, foreign markets, and Prosper. The allocation percentages should be based on your risk tolerance and investment timeframe. The longer term (10+ year) money can have a higher percentage in stocks, the mid-term (5-10 year) money can have a higher percentage in Prosper, and the shorter term (<5 year) money should be mostly in cash accounts or bond funds.

Peer to peer lending in Canada - CommunityLend

Canada's Globe and Mail has an interesting article about the peer to peer loan industry - Fast cash just a click away. After discussing the success of Prosper and Zopa, the article turns to the future of peer to peer lending in Canada.

From the article:

Toronto-based hopes to tap the estimated $110-billion (Canadian) unsecured consumer debt market in Canada as soon as this fall.

"You don't have to get dressed in a suit and sit in a stuffy office in front of a banker asking you all kinds of questions," said Michael Garrity, a former vice-president of marketing at Canada Post's online bill-payment division who co-founded CommunityLend with Colin Henderson, former head of online banking at Bank of Montreal.

"We provide an alternative with a rate that is completely formed by a free market," Mr. Garrity said. The company is awaiting licensing under a host of federal and provincial regulations.

NuWire features Prosper lenders

NuWire Investor has published an article about Prosper Lending which features two prominate Prosper bloggers - Kevin Gillett who authors Rateladder and Technologyguy who authors Lazy Man and Money. We just talked about rateladder and lazy man in our review of top Prosper blogs. NuWire's article was written nearly two months ago but was just made available to the general public in their free section. Here are quotes attributed to the lenders:

Many investors were intrigued by the idea of replacing banks in the lending equation. “It was a very interesting idea to me,” Kevin Gillett, a Prosper lender and the author of, said. “I love the idea of cutting the banks out of the picture.”

Prosper “basically allows me to be the bank, which I really like,” said a Prosper lender who goes by the user name of Technologyguy and authors the site

Prosper has the advantage of independence from the stock market, “so even if it can’t blow the doors off returns that you might see hyped up about it, if it can return 10–12 percent and be orthogonal to the stock market, I think that alone is enough of a reason to invest in it,” Gillett said. Prosper is creating a “completely different asset class,” he said.

Another interesting part of the article is the statistics about the success of Prosper lenders.

Most of Prosper’s 11,500 lenders are seeing competitive returns so far, according to Eric’s Credit Community, a website that analyzes the official data released by Prosper. After adjustments for default risk, 75 percent of all Prosper lenders are seeing a return of more than 10 percent, and 98 percent of lenders are achieving more than 6 percent.

Diversification increases results; of the borrowers with more than 25 loans, 81 percent are seeing returns of more than 10 percent, and 99 percent are achieving more than 6 percent.

Based on the tone of lenders in the forums you would think the returns are even lower than this. Perhaps those that have lost the most are just the most vocal. Technologyguy talks about his concern about not receiving interest on idle money. This is something John Witchel, Prosper CTO and co-founder addressed back in April. Witchel said it is not the priority right now, "it's not the dominant variable. Marketplace liquidity and default performance are the dominant variables that Prosper can influence."

Technologyguy said he would like to see Prosper provide interest on money that sits in a lender’s Prosper account. Right now, he said, he receives no interest on funds that are not invested, and “the money sits around for a long time when it’s being transferred from your bank account into Prosper.”

He said after finding and bidding on a loan, it can take up to yet another month before the loan is fully funded, verified and active. Since the money receives no interest during those waiting periods, “it really cuts into the amount of gains that you can make.”

Kevin and Technologyguy also discuss their concerns with standing orders. Both would like greater flexibility to time standing orders.

Gillett has relied mainly on standing orders and only recently began to experiment with manual bidding. He said recent changes in Prosper have made standing orders less effective. The problem, he said, is with loans that are not autofunding, which means that “as soon as they’re 100 percent funded, they continue to have the auction open and the bids continue to come in” and the interest rates get driven down.

Gillett said his standing orders “would fire and my money would be tied up in this loan that started off at a great interest rate and then by the time the loan actually closed, I was bid out of the interest rate.”

“eBay has taught us all that the optimal auction strategy is to show up at the last two minutes and outbid everybody and win the listing,” Gillett said. “You weren’t in the loan early, no one knows you’re coming, and…that way, you get the best interest rate possible.”

“The time remaining criteria would allow my standing order to basically act as I’m acting in a manual bid, which is to say, watching the interest rates, watching the loans, and then when the loan gets within 30 minutes of the end of its auction, then to have the standing order fire,” Gillett said. Such a system “is absolutely necessary if you’re going to be a standing order bidder these days,” he said.

Lenders with multiple standing orders face special challenges, Gillett said. He uses five standing orders that build a bid ladder, but “they fire in completely random order and I have no control over the order that they fire in.”

Rather than bidding at the most attractive interest rate first, the orders fire randomly. “So I’d like a little bit more transparent control over when the standing orders fire,” he said.

Review: Top Prosper Blogs

Prosper is a social lending marketplace. In this post I wanted to look at one part of that online social aspect - blogging about Prosper.

I've spent several hours searching the interweb and come up with a list of Prosper blogs. I'm sure that I've missed some and ask for reader's help in identifying any additions. - Rateladder is clearly the most prolific Prosper blogger. He has his pulse on the Prosper community and certainly provides a valuable service. He has averaged more than a blog post a day since launching in December 2006 and is still going strong. His most popular post is and your emergency fund. Kevin, the blog author, also runs which provides tools for Prosper lenders. - Wiseclerk is an interesting blog that started about the same time as rateladder. The focus is much broader with attention to all P2P banking sites including a lot of international coverage. Here's a direct link to wiseclerk's Prosper blog posts and posts about Prosper groups. Wiseclerk is the blog's primary author but there are also several other guest authors. My only confusion with wiseclerk is the header says while the site is hosted on - odd. In addition to the blog, wiseclerk offers several useful statistical reports.

Jutia Group - Jutia Group is a finance blog. Stephen Oakes, the author, is the group leader for the aptly named Jutia Group on Prosper. His 45 active loans are earning over 20% since February and he is much more bullish than most investors, "Although picking solid stocks is my expertise and passion, I've found that making diversified loans earning over 20% every year is an absolute no brainer." In my opinion, his best post is about standing orders - not only does he provide a brief tutorial but he shares his own criteria as an example.

Lazy Man and Money - Lazy Man blogs about all things money but his favorite topic is Prosper with over 30 posts. He freely shares the mistakes he has made and has changed his investment strategy from focusing on high interest rates to focusing on AA, A, and B loans. This reminds me of Matt's risk management advice.

Prosperous Land - Mike doesn't post often (maybe a half dozen times a month) but when he does it it's quality. The most valuable post for me was his analysis of default rates on auto funded loans. Based on his stats, they will fail at 2x3 times the rate of non-auto funded loans. He also presents some shocking statistics on how borrowers without verified bank accounts almost always default. Blogs - allows anyone to host their own Prosper blog and currently has eight bloggers which include zcommodore (brand new blog), PrinceOfEgypt (not updated since May), Caladia (nice Prosper anniversary post), Bamalucky (self-described as daily rants and anti-prosper), and bmay2 (group leader of NuBeginnings). The two I'll highlight are Fred93 and Jwitchel. I'll also point out that here on Prosper Lending Review we plan on allowing guest author posts in the near future. This may be a valuable option for people who don't want to start their own blog but have valuable insights to provide to the community outside of the forums. Email me if interested.

Fred93 - Fred is a top lender with over $700,000 invested. He has only blogged three times but they are weighty posts. He has soured on Prosper and has published a couple open letters to Prosper (1, 2). He says, "Sadly, I have to report that my disappointment with Prosper’s management has continued to increase month after month, and my enthusiasm has continued to decline. I’m pretty sure that the majority of things that are wrong can be fixed. However my confidence that Prosper’s management will fix them has simply declined with time as I’ve witnessed their response."

Jwitchel, Prosper CTO Blog - does not have an official company blog. This surprised me, but they make up for it by directly interacting with users in the forums. There is an official company announcements section of the forums and several Prosper employees are active in the forums. John Witchel, Prosper's CTO and co-founder, made the decision to host his blog on instead of the company's official site. In his first post he says, "Following up on my promise to start communicating more, I thought I'd start a blog and is kind enough to hook me up." His posts have been very informative yet somewhat infrequent (four in the last two months). He has blogged about the Prosper collections process, debt sales, debt to income ratio, pre-vetting borrower's income, and interest in idle money among other topics.

There are several blogs, while interesting, are no longer updated.

Money Walks - Lender's perspective on Prosper with an emphasis on data analysis. My favorite post, Blame the Lenders? Or the Borrowers?, shows that HR and E-grade loans make up 80% of the listings. Wow! Money walks, if you read this, I'd love to see these stats run again to see what the marketplace looks like now. I wonder if it has changed in the last six months. Money Walks has not been updated since February.

DebInVenice - coverage and pictures of Prosper Days February 2007.

SeattleEditor's Prosper Blog - has not been updated in over a year but has some good gems among the older posts.

Prosperlicious - Very active blog from March to August 2006 but nothing since.

Group blogs

Craiglisters Group - good tips for borrowers.

Vets helping vets - military group blog with Prosper news, group news, and tips for borrowers.

In addition to blogs, there are many 3rd party statistical tools and group websites. I plan on reviewing those as well in the future. If you know of any websites that I should take a look at please email me or leave a note in the comments. Also, if there are any blogs I have missed please let me know.

As for this blog, Prosper Lending Review, we hope to build a long term resource for those involved in the peer to peer lending community with a focus on Prosper lenders. Right now we have two authors. I'm Tom, also known as Spider5 on the forums, and am relatively new to Prosper. Matt (mateo) has been lending successfully on Prosper for about a year. In our first two weeks I think we have already built a wealth of good content. If you haven't yet, I invite you to subscribe to our daily updates by entering your email in the box on the top right. We plan to continue publishing high quality content. So far here are our most popular posts:

eBay + MySpace + ? = Peer to peer lending - industry review
Do Prosper lenders discriminate?
Prosper lending 101 - review of Prosper's online seminar for new lenders
A Prosper scam: The story of Jessica Wolcott - could be a movie made from this
Prosper: A hands-on education in risk management - avoid HR and E's
Why would a borrower use Prosper instead of a traditional bank?
Prosper lending - How to avoid bankruptcies
When to bid on Prosper loans - not like eBay

I've created a blog roll on this site to make it easy to find your Prosper blogs. In addition, I've created a shared Google Reader page for Prosper blogs and the five most recent blog posts are published on this page. Right now the feeds included on the shared Google Reader page are Wiseclerk, Prosper Lending Review, Prosperous Land, Rateladder, and all blogs. If you have anything you want me to add please send me an email or add a comment.

Tuesday, June 26, 2007

eBay + MySpace + ? = Peer to peer lending

Brad Slavin has written an informative 15-page paper reviewing the peer to peer (P2P) lending industry (pdf) with a focus on Prosper and Zopa. His outlook is very optimistic. I've extracted a few of the highlights from his article. Quotes are in italics.

"The timing is right for sites like Zopa and Prosper, which are part of a broader wave of sites aimed at fostering online communities. These companies are challenging the status quo using an online loan marketplace with a social computing twist. These online lending communities can be considered as a combination of eBay and — a place where consumers come together to loan and borrow money from each other."

It looks like Brad is not the only one that has an optimistic outlook. Prosper just secured an additional $20 million in venture capital and Facebook's Lending Club is off to a great start. He thinks the current conditions are just right for peer to peer lending.

" increase in individual debt, a low return on savings, and increasing asset prices are also changing consumers' borrowing and lending behavior thereby creating a favorable environment for alternative investment platforms such as peer-to-peer online lending exchanges. The success of these web based P2P lending communities can be gauged by the strong growth in their members and loan volume. Zopa has attracted 87,000 members and Prosper currently boast of approximately 100,000 members."

Although he published the article yesterday, Brad must have pulled his stats some time ago. Prosper currently has over 310,000 registered members. Later in the article he mentions that Prosper has loaned $24 million. The figure is now $71 million. Even though his stats are dated that just further reinforces his point that the peer to peer lending industry is in a period of rapid growth. He mentions some of Zopa's awards:

"Zopa won "Internet Innovation of the Year" at the 2006 CNet Technology awards and was named by American magazine Business 2.0 as one of the eleven most disruptive companies in the world."

He did not mention similar accolades that Prosper has won including the #1 website of the year in 2006 by Time Magazine.

Brad talks about the success of other online communities and user generated content including eBay, MySpace, blogs, Wikipedia, Amazon, Flickr, YouTube and others and compares that to the success of the social lending space. I think he is very correct there. Beyond all financial considerations, the social aspect is one of the big allures to many at Prosper. Brad also makes the point that online communities can do what financial institutions do at less cost.

" turns out that online communities can do a lot of what banks, credit card and payday loan companies do and cheaper. The opportunity lies in consumers' mistrust of financial institutions. According to a Forrester study, 'most people believe their banks put their own interests ahead of consumers', and a majority doesn’t think their financial institutions have strong ethics.'”

I have mixed feelings about this statement. In many ways Prosper and other peer to peer marketplaces are less efficient. The cumulative time that dozens, sometimes hundreds, of lenders expend to fund one loan is very high. Although time consuming, in some ways, the social lending marketplace can be more vigilant than banks. The story of Jessica Wolcott's scam is a good example. Hundreds of lenders engaged in online detective work to prevent fraud, something that would have been cost prohibitive for a normal bank.

Brad provides a bullet list of the nine advantages of peer to peer lending. They are:
  • Avoid banks and other middleman
  • Anonymous transaction
  • A whole new asset class
  • Optional rates and loan amount
  • Lower interest rates for borrowers
  • Higher returns for lenders
  • Faster and easier process
  • Increased transparency and control
  • Satisfaction

I disagree with one of his points - anonymous transaction. He argues, "All transactions are done anonymously and borrowers are not inundated with emails and telephone calls as are borrowers registering with traditional online lending companies." I think that loans which occur on Prosper are less anonymous than loans might be through a bank. You place your credit history and other personally identifiable information where they can be accessed by anyone. Even though it is against Prosper's TOS, group leaders bombard borrowers with invitations to join their group. Many borrowers send pay statements and other personal financial records to group leaders to become vetted.

Brad makes a point about the imbalance between lenders and borrowers.

"...the biggest problem at the moment at these online lending marketplaces is theimbalance between number of lenders and borrowers. There is just not enough money in thesystem to meet all the reasonable needs."

He's right. There are many more borrowers than lenders. This is good for lenders but, in my opinion, if the market were to become much more competitive then interest rates would come down and lenders will lose the incentive to bid. I don't think interest rates can come down much more and still provide an attractive investment option to lenders. In addition, according to a post on Money Walks, about 80% of the listings are made up of E and HR credit grades. As Matt has discussed earlier, too many of these high risk loans on Prosper default to make it worth bidding.

There is an interesting comparison between Prosper and Zopa in the article. Some of the information is dated but I thought the paragraph on diversification was interesting.

"Zopa extensively use diversification as the key to mitigate default risk. Zopa is able to manage default risk by taking a more protective approach with respect to lenders by only accepting borrowers with high credit quality and by forcing lenders to diversify their loans across at least 50 borrowers. At Prosper, lenders can diversify, but are not forced to do so. It allows lenders to bid small amounts on all or part of loans; it is easy for lenders to create well-diversified portfolios."

I didn't know Zopa forced diversification. I can see pros and cons to that. It probably reduces the lenders remorse of inexperienced lenders who place bad bids but I can see how it might frustrate more experienced or aggressive lenders.

Brad highlights the social aspect of Prosper.

" was created with the objective of making consumer lending more financially and socially rewarding for everyone....Compared to Zopa, Prosper has added a number of community elements, the most important one being groups. Prosper relies on a strategy borrowed from hoi: shame, believing that people repay real-world co-operatives because they fear losing face among peers. It works on the principle that people from close communities act more responsibly towards each other."

I think this statement is right on the mark, but also runs counter to his earlier contention about the ability of borrowers to receive funds anonymously through the peer to peer marketplace.

Brad wraps up the article by mentioning several players in the peer to peer lending marketplace. Many I had not heard of before - kiva, PalTrust, Moneytwins, Rippleplay and CircleLending. From his conclusion:

"Currently these websites work for relatively small, unsecured, and primarily personal loans. With maturity the market may potentially see some other entrepreneurs entering the market and eventually starting up other financial services e.g., mortgages for homeowners to finance purchases or refinances. Such sites could ultimately supplant the existing financial institutions. As a response, the incumbent financial institutions may either start their own lending marketplaces or will partner with the niche P2P lending marketplaces."

What do you think? Will the peer to peer loan marketplace expand to include mortgages and other financial services? Is the outlook as optimistic as Brad contends?

(Thanks wiseclerk for the tip.)

Do Prosper lenders discriminate?

When you sign up as a lender you are required to agree to a Lender Registration Agreement. Among other things, you agree to not discriminate against borrowers based on race, color, religion, national origin, sex, marital status, age, sexual orientation, military status, or the borrower's source of income. Each lender agrees to follow these non-discrimination guidelines.

The publicly available data from Prosper does not include these identifying items, so it is difficult to do any kind of analysis to determine whether discrimination exists in any overall statistical sense. After reading this list, however, it seems to me that unless you set up a standing order to auto-fund loans, it is difficult to avoid discriminating based on some of these items.

Here are some examples:

Two of the items listed are military service and source of income. I have bid on several military loans specifically because I consider them a lower risk. My reasoning was that the military can take disciplinary actions against service members that default or are late in paying their obligations including revoking their security clearances. Also the military is a very stable employer - I don't expect the military to be doing any layoffs any time soon. For a similar reason I recently bid on a loan from a Microsoft employee. Like the military, Microsoft is a large stable employer with low employee turnover. So, the question is, by taking employer or military status into consideration are you in fact discriminating in violation of the lender agreement and federal law?

My pro-military and pro-stable employer bias is not based on hard statistics, but is instead more of a personal bias since my brother is in the military and I work for a large stable employer. According to this Prosper forum posting more than 6,300 troops have had security clearances revoked for financial reasons during a four year period. This indicates that although the military does have additional penalties for not paying debt that doesn't stop everyone in the military from going late on loans. It would be interesting to see actual stats of how these groups compared to the general population.

Age is also mentioned as something that is protected from discrimination. Perhaps Prosper took care of the biggest instances of this when they eliminated the NC category, and prohibited people without credit from applying for loans. Most of the people in the no credit category were there because they were too young to have an established credit history. In eliminating this category, was Prosper discriminating or is it okay to discriminate against a group as long as they fall into a nice credit category so the basis can become the credit grade rather than the age?

Marital status is also listed as an item that should be excluded from discrimination. Personally the only time this is an issue for me is if they mention in the listing that they are going through a divorce or have recently gone through a divorce. When someone goes through a divorce it usually has a measurable impact on their finances. There are two households to support instead of one, attorney fees related to the divorce, and potentially ongoing custody disputes that can cost tens of thousands of dollars and drag on for years. According to the National Association of Bankruptcy Attorneys, divorce is among the top three causes for unmanageable debt along with loss of job and medical expenses. So, I try to avoid these categories because I want to have as few defaults or late payments as possible. Is avoiding loans that mention divorce an instance of discrimination based on marital status?

As far as the remaining items go, race, gender and national origin are not usually listed in the details of the loan. However, many borrowers include photos of themselves as part of the listing. On the Prosper forum there is a series of over 1500 posts titled "Photos that make you want to bid..." The posts contain many humorous photos that include things such as a listing for Paying for Medical Bills that included a photo of a dog with his leg in a cast. However, there are also many posts indicating that some people have a tendency to bid on listings when they find the photo attractive. After several unsuccessful attempts at funding, one member of the military who is serving in Korea changed his profile photo to an attractive Korean woman. Once he did that the bidding activity on his loan significantly increased.

I think the primary concern for lenders is earning a good rate of return on the money they invest in loans. However, all of the lenders at Prosper are human, and I think it is clear that it would be impossible to eliminate all forms of discrimination from lenders who are bidding on the loans.

So, if you are a borrower what should you do to avoid being discriminated against? The answer is that all of the non-credit related information that lenders are using to discriminate between loans is being provided by the borrower. So, if you are worried about a lender discriminating against you based on your recent divorce don't write "I am consolidating credit debt that I acquired as a result of my recent divorce." Instead, just write "I will be using this loan to consolidate my credit card debt." It is not necessary to provide the lender with information about your past or why you got into the situation you are in. If you are worried about someone discriminating against you based on your photo, you can use a photo of your favorite flower, your pet, or a nice sunset. In short if you are a borrower, you are not required to disclose any of the items that could be used to discriminate against you. If you do disclose some of these items, you do so at your own risk. I think it is reasonable for lenders to use any of the voluntarily provided information in making subjective judgments on whether or not to fund the loan.

Prosper Lending 101

I just attended Prosper's lending webinar, "Learn how to earn great returns on Prosper loans!" which was announced last week. It was an informative session taught by Prosper's Brain Mass geared toward the brand new lender. This was the agenda:
  • Transfer money
  • Basic search
  • Anatomy of a Listing
  • Watch Lists
  • Bidding
  • Advance search
  • Marketplace performance data
  • Standing orders
  • Example strategies
  • Q&A
  • Survey

To explain most of the features covered in the agenda, Brian navigated his account on a shared view. He searched for, found and explained each part of this listing and then actually bid on it. He showed us how to use advanced search and save a search.

This was my first online seminar using this webinar program. When you register you login to a site that gives you a shared view of the presenters screen. In addition, you dial in via your phone for the audio. Unfortunately, everyone had the ability to talk which created a noisy line. I joined the conference call four minutes prior to the start and I was the 12th person to join. I don't know how many total people participated but there was one person on the line that continued to press buttons on his phone and make noise disturbing the call for everyone else. Brian kept reminding users to hit *6 to mute their line but not everyone complied. That is really my only complaint about the seminar. I recommend Prosper get or use the technology to mute all callers to prevent further webinars from being interrupted.

The webinar took a total of 45 minutes which left 15 minutes for questions. Brian was not able to get to all the questions, but here are some of the questions that were asked. These are the lender's questions and Brian's answers, in my own words, based on what I heard.

  • Why are some loans featured?

It's random. Borrowers cannot pay to be featured.

  • Why bid small amounts instead of large amounts?

Diversify and reduce risk.

  • What is the difference between current and open credit lines?

Current are in use within the last six months. Open lines may have been open for years but are not being used and the credit card is not making reports to the credit reporting agency.

  • Are groups made up of borrowers or lenders?

Borrowers. There is no advantage for a lender to join a group and right now there are no groups for lenders.

  • How do group leaders check out borrowers?


  • Can anyone become a group leader?

Yes. You just need a social security number.

  • When is the service fee deducted?

Throughout the life of the loan.

  • If you are outbid does the money return to your account immediately?


  • What happens if the loan is not 100% funded?

Funds are returned immediately.

  • How is the interest income reported for taxes?

Form 1099 is sent if you earned over $600 in interest income.

  • Are borrowers more likely to get funded if they are in a group?

Historical trends do not show that borrowers are more likely to get funded if they are in a group.

  • How do you find the loan repayment schedule?

Go to Borrow > Loan Calculator

  • Is there any way to cash out of your account?

Not now. Prosper is working on a secondary market for loans. No time line yet but we hope to offer it at the end of the year or early next year.

  • If two lenders have the same interest rate, does the person who bid the most money win?

No, it is the person who bid first. (I'll just add - if you are looking for information about bidding I recommend our Prosper bidding tutorial.)

I'm glad that Prosper is offering the online seminar and I think it will be useful for new lenders. Brian said they plan to continue to offer it twice a week. His comments about the secondary market for loans was most interesting.

Monday, June 25, 2007

A Prosper scam: The story of Jessica Wolcott

Jessica Michelle Wolcott is a girl in her early 20's who goes by the username of JessM on Prosper. She applied for a loan 6 times on Prosper, but was never funded because she has HR credit and lives in a state where the interest rate is capped at 15.75%. In the listings she claimed that her primary job was marketing and she made $60,000 per year. She also mentioned that she also did some modeling for Pantene Pro-V from which she pulled in an additional $10,000-$60,000.

After the six unsuccessful listings, a new listing appears. This time it is Jess's mom who has AA credit taking out a $20,000 auto-fund loan at 15% to help out her daughter. In this listing her mom claims that the reason her daughter has poor credit is not due to all the late payments and missed payments on the account. Instead, she attributes it to credit agencies misspelling her name.

The wording and writing style in her mom's post was very similar to Jess's original posts. Several lenders suggested that Jess probably wrote it herself and many have wondered whether she did so with her Mom's permission or whether she just borrowed her social security number and posted it without her mom's knowledge.

Alan, an active Prosper lender and frequent poster on the Prosper blogs, did a lot of work in the forums to warn people about inconsistencies in details of the different loan requests and warned that it was probably not a good idea to fund the loan. In spite of his warnings, some lenders couldn't resist 15% on a AA loan and the loan ended up funding anyway.

Okay, now on to the good stuff.

Several people on Prosper are good at detective work. When a large AA loan goes late right away it raises suspicions and people start to poke around to see if they can find out why. Their detective work and updates to the Prosper forum allow us to bring you this real life soap opera. The following is a summary of the story as it unfolds in the Prosper Forums.

First we learn that Jessica Wolcott, 22 years old, pleaded guilty to extorting $125,000 from a CEO of a fortune 500 company. She met him on Craigslist and then threatened to go public with details of the extramarital affair. The details were first reported on the Smoking Gun which reported that she used some of the money for an Apple laptop and a 2001 Saab convertible coupe. The mom's listing had mentioned that same Saab convertible. Through some detective work done by Prosper members, we later learn she purchased the Saab convertible on eBay and it had a salvage title. We also learn that she had stashed away 119 ounces of gold (about $74,000 worth) on deposit at e-gold. Apparently she hoped that money would be out of the court's reach. Upon arrest she surrendered what was left of the $125,000 and was then released on $15,000 bail. As part of her release agreement she was ordered not to travel or use a computer and was ordered to undergo psychiatric treatment.

On November 27, 2006 she changed her plea to guilty and was scheduled to be sentenced in February. At this time we also learn of some additional inconsistencies in the loan listings. According to Jess' mom, at one point she was in Australia to do a photo shoot yet, according to the US attorney, she never had a passport. We also learn that in April 2006 she was evicted for failure to pay rent. That doesn't jive well with the assertion that she had a wealthy mom and $24,000 in the bank.

The story is picked up by the national news media with a NY Post article and then a second follow-up article. From these we learn that the executive that was being extorted is Wandschneider from Pepsi Bottling Company, and that he had willingly given her $30,000 before she tried to extort more from him at which point he got the FBI involved.

PBS runs a report that Pepsi Bottling Group Inc., the worlds largest maker of Pepsi Cola products starts investigating whether Wandschneider used the computer for non-work-related activities following revelations that he had e-mail exchanges with a woman that tried to extort $125,000 from him.

At this point the "Mom" finds the posts about her daughter in the Prosper Forums and tries to defend her daughter. Many lenders wonder whether this poster is the mom, or whether this is the daughter pretending to be the Mom. The "Mom" claims that Prosper members had asked for explicit photos, dates, meetings in person, and other inappropriate requests in exchange for bids or lending money to her privately.

The story runs on Gawker and includes a mention of her Prosper loan attempts. The story links to her Prosper member page which has since had the content deleted. In spite of the fact that one of her bail provisions was that she could not use a computer she managed to delete the information in her Prosper profile, as well as the information in her MySpace pages.

As the story unfolds, Fox news runs a special where they talk to Jessica Wolcott's ex-husband Kyle Strait. He claims she stole $15,000 from his bank account and racked up the same amount in loans in his name while he was overseas in the military. He said "she has to be stopped" and explained that Wolcott's fantastic stories included claims that she inherited $56 million from her dad when he died. We also learn of another man, Domin Aleadri who became engaged to her unaware that she was already married. After breaking up with her she sent Aleadri sonograms claiming to be pregnant with twins, but he later learned that the fake sonograms were just another fraud.

We also now learn that because of this incident Wandschneider, the Pepsi Cola executive and father of three, is no longer employed at Pepsi Bottling Group. Company officials refuse to comment on whether he was fired or whether he resigned from his position which has a $6 million dollar annual salary.

Jessica's ex-husband, Kyle, joins the Prosper forum and says, "This is like a huge closure for me so it's good to see she finally spun so far out of control that other people got to see it. I'll never get back what she took from me, but the media and you guys are making up for that." She had told her ex-husband that she had 7 middle names Jessica Michelle Monica Elizabeth Dakota Raymita Tatiyanna Rachel Wolcott but that her real name was the Indian name Ewakailakaipu.

As the story hit papers in her hometown, other people who personally know Jessica join the forum and suggest that Jessica's mom wouldn't do anything to protect her and that she was kicked out of the house at age 15. This leads additional credence to what lenders assumed all along - that Jess was impersonating her mom when she took out the Prosper loan. These people also confirm that everything in the original loan requests from Jessica and the subsequent loan request is a hoax and completely untrue.

From these hometown friends of Jessica we learn of a past filled with a web of lies that include faking death, and sending pictures of herself all bruised up with bruises that were created with Halloween makeup. Other incidents included pretending that someone had broken into her apartment and tried to kill her. She went as far as calling the police to have some of her friends investigated.

ABC News runs a two page story that confirms that Wandschneider was fired from his position in the company. DealBreaker runs a story that claims that in addition to eight middle names and an Indian name, Jessica Wolcott has 50 different aliases on the internet.

Jessica's ex-fiance, Dominic Aleandri, joins the Prosper forums. Both he and Kyle, the ex-husband, get interviewed by Inside Edition. Dominic claims he still doesn't know who she really is, but that she was brilliant and clever in spinning her lies. He claims to think that maybe her Mom was involved in some of the schemes and in backing the world of lies about Jess.

February arrives and the U.S. probation officer assigned to the case requests an adjournment saying that Wolcott should first undergo additional psychological examination. The request is granted by the judge and the new sentencing date is set for April 20, 2007.

While awaiting her court date, Jessica is involved in a bar brawl that leaves her victim with 11 stitches. She is again arrested and ordered to wear a monitoring bracelet.

Once again there is a postponement in the sentencing, this time it is set for June 15th. As articles are written about this postponement we learn of additional scams involving the owner of a car dealership. To make a long story short, the owner met up with Wolcott in Florida, and quickly proceeded to buy her a NSX valued at $60,000. When she tried to extort him for additional money, he repossessed the car and tried to turn the tables on her by threatening to reveal her scam. She relented and decided to leave him alone.

The sentencing date has now passed and according to court records her sentencing has happened. Public records that are supposed to be available related to her sentencing are not available. Searches related to the case on PACER do not show any updates. Phone calls to the court indicate that her case is lost somewhere.

So, the mystery and intrigue of this Prosper soap opera continue. I will post major updates in the comments section of this article if and when they become available.

Update (12/19/07): Notorious Prosper borrower gets 21 months in jail

Update (2/10/2008): JessM in trouble with the law again

Friday, June 22, 2007

TechCrunch's bias - Prosper versus Lending Club

I'm a big fan of Michael Arrington's TechCrunch. It's the premier blog about Web 2.0 products and companies. According to Technorati, TechCrunch is the fourth most popular blog on the net. Many new web start-ups can trace their success back to a TechCrunch anouncement.

As I compared TechCrunch's anouncements this week about Facebook's Lending Club and Prosper, it seemed to me that TechCrunch favors Lending Club. Despite being the clear leader in social lending, TechCrunch has only covered Prosper three times in the last 18 months. First when they launched in early 2006, when they anounced milestones last October, and then this week when they raised $20 million in venture captial. Lending Circle received milestone coverage when they reached $100,000 in loans while Prosper didn't receive milestone coverage until they reached $20 million in loans.

In general, Facebook seems to be a TechCrunch darling. When Duncan Riley, one of TechCrunch's writers wrote a post that was somewhat critical of a Facebook feature, Arrington chided him in the comments, "errr, Duncan. This is a pro-Facebook blog. Didn’t you get the memo?"

Prosper could probably be doing more to court TechCrunch. The news about Prosper's $20 million in venture capital was broke by rateladder after Prosper's CEO told a room full of people at Prosper Nights SF. TechCrunch didn't pick it up until hours after a press release the next day. Perhaps giving TechCrunch an early tip about the news would help maximize media coverage.

This couldn't be better - while I was writing the post another Facebook social lending story has hit TechCrunch's front page. This is about ChipIn, a free widget based service that enables users to collect money. From their report:

ChipIn, a free widget based service that enables users to collect money has launched a Facebook application that brings micropayments to Facebook.

ChipIn on Facebook supports existing Facebook events or can be used separately with ChipIn created events. Creation of new “ChipIn’s” is simple, the ChipIn Widget can be customized using photos from a users Facebook account and each ChipIn can also be promoted directly to Facebook friends.

We covered Lending Club, the exclusive Facebook P2P lending service on June 20; ChipIn is at the other end of the spectrum targeting micropayments, yet together they demonstrate the continuing growth of finance on Facebook. There is any number of new Facebook applications being launched daily, and whilst many provide a wow factor and are useful, not that many to date have a real world financial use. It’s not too farfetched to imagine ChipIn being used as a political or charity fundraising tool on Facebook in the near future.

The social lending market is heating up and we are going to see more and more competition against market leader Prosper. The largest market for social lending, in my opinion, is among the web savvy. Prosper would do well to promote their services via the blogging world instead of a press release. Perhaps that is their goal with the referral program?

Free online seminars for lenders and group leaders

Prosper is hosting a free online seminar for lenders. Topics covered include:
  • Create a bidding strategy
  • Create standing orders that will "carry out" your bidding strategy
  • Set up watch lists to notify you when choice listings come up
  • Use additional lender resources

The seminar is an hour long and will be held on June 26th, 28th, and July 18th.

A second online seminar, How to have a 5-star group on Prosper, is for group leaders and will be held on the same three days.

If you are interested in attending and did not get an invite, email me or leave a comment. I plan on attending and will cover the highlights in a future post.

Wednesday, June 20, 2007

Facebook's Lending Club passes $100,000 mark

Just following the announcement that Prosper secured an additional $20 million in venture capital, Facebook's Lending Club made an announcement of their own - they just passed the $100,000 mark in loans to users. While not even close to the $70,000,000 that has exchanged hands on Prosper, it is significant considering Lending Club has only been live for one month. An additional $212,650 in loans is expected to close in the next 12 days.

Lending Club differs from Prosper in several ways. Most notably, they do not provide an auction format. Lenders and borrows can simply commit funds at pre-determined interest rates. Lending Club is also limited to Facebook members and hopes to leverage trust from established social networks.

Prosper: A hands-on education in risk management

For some new lenders on Prosper it is a hands-on education in Risk Management. There are several different ways to learn about managing risk. Most colleges have economic courses on risk management, and there have been lots of books written about the topic and how it relates to investing. My favorite book on the topic is a book called Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein. I thoroughly enjoyed reading this book, and highly recommend it.

There are too many important concepts to cover them all in one article, but the two most important items are diversification and risk adjusted return.

Let's say you have $1000 to lend. If you put all of that on one or two loans then you run the risk of that loan defaulting and losing all of your money.

Here are some lenders that did just that:

If these lenders had instead diversified, then like this lender the default would be a small part of the overall portfolio and would not have a significant impact on the overall performance.

This concept extends beyond Prosper and is the reason that financial planners often counsel investors to buy mutual funds or index funds which allow the risk to be spread across a large group of stocks rather than putting "all your eggs in one basket" by purchasing a small number of individual stocks.

The next concept is risk adjusted returns. This is where Prosper's Marketplace Performance Data will help us out. Adjusting for loans that are too recent to go late or default we get the following percentages (by number of loans):

  • AA: less than 1% late or in default
  • A: 3% late or in default
  • B: 7% late or in default
  • C: 10% late or in default
  • D: 13% late or in default
  • E: 28% late or in default
  • HR: 45% late or in default
  • NC: the performance wasn't good on these loans, so Prosper has discontinued allowing people with no credit to borrow

With new lenders, I think there is a great temptation to bid on HR loans. You see a 29% interest rate, and a nice story that explains how the money will be used, and think "Wow! why chase after a 12% A rated loan when there are all these HR loans at 29%?" The answer is that once you subtract the 45% to account for the HR defaults you end up with a return of -16%. At a 29% interest rate on an E loan you end up with a 1% return after accounting for defaults. If you hear someone in the Prosper forums talk about having lost money on Prosper there is always one of two things going on: either they didn't diversify their portfolio or their portfolio is heavily weighted with HR and E loans. I have yet to come across a diversified portfolio that avoided HR and E loans that isn't doing well.

Here are how the stats actually end up by credit grade:

  • AA: Expected Rate 9.5% (Start with an average rate of 11% and subtract 1% for defaults and the 0.5% Service fee)
  • A: Expected Rate 9.5% (Start with an average rate of 13% and subtract 3% for defaults and the 0.5% Service fee)
  • B: Expected Rate 7.5% (Start with an average rate of 15% and subtract 7% for defaults and the 0.5% Service fee)
  • C: Expected Rate 6.5% (Start with an average rate of 17% and subtract 10% for defaults and the 0.5% Service fee)
  • D: Expected Rate 7.5% (Start with an average rate of 21% and subtract 13% for defaults and the 0.5% Service fee)
  • E: Expected Rate -4.5% (Start with an average rate of 24% and subtract 28% for defaults and the 0.5% Service fee)
  • HR: Expected Rate -21.5% (Start with an average rate of 24% and subtract 45% for defaults and the 0.5% Service fee)

Keep in mind that these stats are based on a historical average which may not predict future results. Also, this is based on only about 18 months of data on 3 year loans. Once more longer term data for a larger number of loans is available these types of statistical analysis will become more precise. What these statistics do suggest is that, surprisingly enough, borrowers with A and AA credit end up being the best long term risk adjusted investment, and can be expected to return about 9.5%. Compare this to other investments like CDs or bonds and this is a really great investment return.

As you can
see in my portfolio, 8 of my 15 loans are in the AA category and none are in the E/HR category. The B-D category still has a reasonable 6.5-7.5% expected return so, while not as good as A or AA, I still fund some of those loans if I find one that I think is a better than average loan for that credit group.

If you start lending after having a understanding of these two concepts I think you will do very well. If not, I think you will learn these concepts along the way.

Here is a good example of a lender who learned along the way. He goes by the name of BigGulp and is active in the Prosper Forums. What you will notice by looking at his loan details is that of the first 50 loans he funded, only one was to borrower with a credit rating of A or higher. Several defaults and late loans later he learned his lesson. Now, looking at his most recent 7 loans, 5 of them were to A or higher credit ratings. And, in the past 2 months none of his loans were to HR or E borrowers. So far he has earned about 1% on his portfolio after subtracting for defaults. If you were to take away the E and HR loans from his portfolio he would be at over 10%.

Prosper secures an additional $20 million in capital

Rateladder broke the news last night based on a tip from Prosper Nights SF - Prosper secured an additional $20 Million in Venture Capital. It was confirmed this morning with a press release. Rateladder quotes someone, not sure who, as saying, “We weren’t looking to raise money, but it is a good market to raise funds right now.” According to the press release, this $20 million was led by DAG Ventures and Meritech Capital Partners and included current investors - Accel Partners, Benchmark Capital, Fidelity Ventures and Omidyar Network. This brings the total capital raised to $40 million. They had to figure out somehow to pay all those referral fees, right? Chris Larsen, Co-founder and Chief Executive Officer of Prosper said, “This latest round of financing provides us with considerable resources toward maintaining our leadership position and continuing to rapidly grow the Prosper marketplace.”

Update: Rateladder updated his post (and added a comment here). The quote above is from Chris Larsen, Prosper CEO. Also, see TechCrunch's coverage here.

Tuesday, June 19, 2007

Why would a borrower use Prosper instead of a traditional bank?

The following question that a reader left on Tom's OmniNerd article inspired me to write this post.

What makes me curious is this: why don't the A or AA folks just borrow from a bank? The rates seem high compared to banks'. My perspective is that of someone who has only ever borrowed with collateral--a car or house--maybe unsecured loans just run higher, but aren't a lot of these people using their home equity as collateral?

The question was a good one and one that many lenders have wondered about. After all, you can get a mortgage loan right now for between 6-7% and, with good credit, you should be able to get a car loan at less than 8%. So, why pay 9-12% on Prosper if your credit is perfect?

Well, interest rates have been rising recently and many people who have not been to a bank for a personal loan might be surprised by the current rates:

  • Key bank is at 12.24% with $99 in fees for a $5000 loan at 36 months
  • America First CU is at 12.75% for a $1000 loan at 36 months
  • Chase is at 13.49% with $75 in fees for a $2500 loan at 36 months
  • Bank of the West is at a whopping 16.25% with $50 in fees for a $5000 loan at 36 months

Keep in mind that these rates assume that you have very good credit. Add to this that the average credit card rate is at 18.9% according to American Consumer Credit Counseling, and you can see that Prosper rates are less than or comparable to other rates in the industry for unsecured debt.

So, why would anyone pay these rates when you can run out and get a home equity line of credit for less than this and get an extra tax deduction to go along with it? The answer is that not everyone owns a house, or has equity in their house that they can tap into. Even among people who do own a house it may require several hundred dollars in fees for appraisals, title transfer, and processing fees that are common throughout the mortgage industry. So, if you add those onto a $5000 loan you may be taking a 5-10% hit right from the start.

Same is true for a car loan. Many people, even those with good credit, do not have a car that has been completely paid off that they can use for collateral. If they do, then taking a car loan also comes with processing and title transfer fees. It seems that you can't do anything at a bank without running into fees.

So, there are plenty of good situations where a borrower with good credit can save money by obtaining a loan on Prosper rather than going through a traditional bank. That does not mean that it is the best choice for all borrowers. I mentioned in an earlier post that it doesn't make sense for a borrower to re-finance a student loan on Prosper. This is also true for house purchases and new car purchases. When I come across a listing that doesn't make sense to me, I don't bid. It doesn't make sense to me for someone to borrow at 12% here to help them purchase a house or car. However, it does make sense to me if they are refinancing credit card debt or paying for a wedding. Matt's advice: if the why part of the listing doesn't make sense to you then don't bid on the listing.

If you are new to Prosper, start borrowing here.

Prosper article on OmniNerd

I just wrote a short article, Prosper - eBay of Loans, which you can find on OmniNerd is a great site with many well-written informative articles and a very smart community. Their tagline - professional wrestling for the wicked smart! I look forward to reading OmniNerd's comments and user opinions about Prosper.

While we are talking about finances and OmniNerd, I'd recommend these two recent articles:

Monday, June 18, 2007

Prosper lending - How to avoid bankruptcies

When lending money to someone on Prosper the worst case scenario is to have someone go bankrupt. At least with other types of defaults you will see a small amount of money returned when the loan is sold to debt collectors. This post is on how to spot and avoid loans where the borrower is planning a bankruptcy.

First the obvious case: when a borrower comes out and says that he needs the money to start a chapter 7 bankruptcy process then it is probably wise to avoid that loan. Here is a borrower that did just that. The scary thing is that if you don't read the listing where the borrower explains what the money will be used for, or set your loans to auto-fund based on a set of criteria then you could inadvertently end up funding a listing like that. Fortunately for Prosper lenders, this loan did not fund and no one lost any money on it.

One thing that might really surprise you (it did me) is that of the 9 loans that have defaulted due to bankruptcy only one of them was in the HR category while 2 were B's and one of them was an A. None of these loans made any payments, they just took the money and headed into the bankruptcy process.

So, what kind of patterns do we see in these loans that went bankrupt? Six out of the nine loans (a full 66.6%) were set to auto-fund at rates between 14.25-30.75%. All of these auto-fund rates were well above the average rate for the credit grade (the 14.25% was set on the A rated loan). If you are a borrower in process on a carefully planned bankruptcy then why not set the loan at a high auto-fund rate? That way you get the money sooner, and why care about a high interest rate when you don't plan on paying it back? Keep in mind that very few of the overall loans are auto-fund loans, and a much higher percentage of auto-fund loans turn into late or defaulted loans when compared to non auto-fund loans. So, while it can be really tempting to grab a few extra percentage points of interest, it turns out not to be worth the risk. Matt's advice: avoid all auto-fund loans (you can recognize them by looking for the yellow lighting bolt next to the interest rate).

Looking at the listing text for these loans, they mention a variety of reasons: divorce, medical bills, "an emergency that happened to my family", dental work, new businesses, and a new job. Two of them mentioned that they planned to "be out of debt soon". Interesting how taking an additional loan could help someone be out of debt soon, but the bankruptcy helps put that into context.

There have been some other listings that have raised my suspicion. For example, I have seen a couple of listings where people fresh out of college are trying to refinance their student loans. Now, you might ask, what is wrong with refinancing student debt? There are two reasons this is a red flag for me: First, thanks to the federal government, student debt usually has generous interest rates, and can be financed over a long period of time which allows for low monthly payments. Refinancing this through a Prosper loan would generally increase monthly payments by shortening the timeframe of the loan to 3 years, and it would likely end up at a higher interest rate.

So, why would someone do this? The answer is likely a carefully planned bankruptcy. Understanding a little about the bankruptcy process helps shed some light on how clever this is. In bankruptcy there is something called "non-dischargeable debt." This refers to debt that can not be eliminated through the bankruptcy process. This includes student loans, child support and alimony, taxes, divorce debts, court imposed restitution, court fees, and theft. In a carefully planned bankruptcy, people look to turn non-dischargeable debt into regular debt that can be eliminated in the bankruptcy process. So looking at the list gives us some things to be aware of.

Note that fortunately for Prosper lenders neither of the two student debt listings mentioned funded, so Prosper lenders did not lose any money on those two loans.

Friday, June 15, 2007

Prosper referral program

Prosper announced their referral program one week ago. The details are pretty simple - refer a lender and you both receive $25 after the new lender funds a loan or refer a borrower and you receive 0.5% of your friend's loan amount as soon as your friend's first monthly payment clears. So far, the program has received little attention. Prosper has not advertised it prominently on their site. You actually have to look around a little to find it. Perhaps they want a slow release?

They did send out an email yesterday which revealed a few more details. They said when you refer your first active borrower or lender, they will send you a "stylish" black Prosper t-shirt. They are also running a ticket to "Proper in Las Vegas" Sweepstakes. Each time you refer someone you are entered in their drawing.

They also announced the top 10 referrers after one week. Here's the list along with information on why they might be doing so well.

#1 - loansearchers - loansearchers is the group leader for Loan Searchers. Although the group started in March it does not have any members, listings or loans. Their group description indicates they have many online resources. It looks like that must be true and they have used that same online community to move to the top of the referral list. Here's what their group description says:

While new to, we have over 4 years experience in helping consumers find lenders. We advertise online which helps to bring new consumers into the community. We will be utilizing many of our other online resources to strengthen our group and community. We will strive to create one of the most dependable and marketable wiring between lenders and consumers as possible on

#2 - nonattender - nonattender is the group leader for -------ians. The group has 6 members and 1 loan.

#3 - TechnologyGuy - TechnologyGuy authors and often writes about Prosper. I just read through some of his posts and they seem pretty informative. He is also a member of the RateLadder group.

#4 - JaredD - Hmm...Jared's from Nevada. I guess he's not too motivated to win that trip to Las Vegas. :)

#5 - AdvisorGarage - Runs Advisor Garage, a site for entrepreneurs. He advertises Prosper on his site and has started the Advisor Garage group which targets "entrepreneurs looking for micro loans before they get to the angel or venture capital stage." The group has 23 members.

#6 - lifesettlementadvisor - Brand new Prosper member. Signed up on June 11th after the referral program was launched. Looks like he has made more money from the affiliate program than from lending through Prosper.

#7 - FitzNDR - Group leader for New Day Rising Loans which describes itself as "An extremely selective group that is designed solely to get good borrowers funded." He has a strong portfolio with no late loans in the six months since he started lending.

#8 - RateLadder_com - Group leader for RateLadder and runs He also runs the statistics site ProProsper. He blogged about making the Prosper's top ten referral list and said he has "4 borrowers (3 with listings) and 2 lenders (both with bids) and 10 others without a role yet."

#9 - cardinal04 - Group leader for Stanford Students & Alumni. The group has 42 members and 3 loans. Cardinal04 has a degree in Biological Sciences from Stanford in 2004 and now works in the biotech industry.

#10 - tehc0w - Member of SA Goons, a large group with 166 members, 1 listing and 16 loans.

Not surprisingly, most of the top referrers are already very active in the community. Over half are group leaders. Several of the others run prosper websites or blogs. We wish them all very well. Perhaps we will try to interview some of the referral leaders to see if they have any tips for the rest of us.

When to bid on Prosper loans

On eBay, there are tools that allow you to set a bid time, and swoop in and bid in the last second to win an auction. Getting your bid in at the last second prevents others from outbidding you and stops them from seeing in advance what you are doing. I was recently watching a house sell on eBay, and the winning bidder placed their first and only bid in the last seconds of a 30-day listing to win the auction.

On Prosper, the bidding is not quite as intense because multiple people can win small bids, so for someone to outbid you they may have to outbid several other people first. It is, however, helpful to understand the how the bid process works so you can make an informed decision when placing a bid.

First, the borrower chooses whether to auto-fund the loan or to open it up for bidding for a certain period of time. Let's say the borrower chooses to auto-fund the loan at 29%. This means that as soon as the loan is fully funded the bidding will end and the borrower will pay 29% interest; the rate will not get bid down. Auto-fund loans are denoted with a yellow lightning bolt next to the rate on the listing. Borrowers choose this option to get access to the money sooner rather than waiting for the rate to get bid down over several days. For this reason some lenders are wary of auto-fund loans especially in the high-risk credit group. Lenders see this as an indication of a desperate borrower that can't wait the few extra days to save a lot of money, or a borrower that doesn't care about the interest rate (possibly because they don't plan on paying back the loan).

If you do want to bid on an auto-fund loan you will need to make the bid before it hits 100% or the listing will close.

Most loans are for a set time period. These loans will show a green progress bar indicating what % of the loan has been funded. The loan will remain at the starting interest rate until the loan hits 100% funded. At that point each person that bids at a lower rate will knock off someone with a higher bid rate. As this happens the interest rate on the loan will be reduced to the highest rate among the group of winning lenders.

Let's give an example:

Bob the borrower starts a loan of $1000 at 16% interest. A, B, C, D, and E are lenders.

  • A bids $500 at 16%
  • B bids $300 at 12%
  • C bids $400 at 15%

Now the loan is fully funded. C's bid reduces A's winning bid amount from $500 to $300 since C was at a lower rate. But there is still time left on the auction, and more lenders arrive.

  • D bids $100 at 15%
  • E bids $500 at 14.98%

So, the winning bids on the loan end up as follows:

  • B - $300
  • C - $200
  • E - $500

The questions are: What is the rate that the lenders make and why is C on the loan but not D when they bid the same amount?

First, the lenders make 15% in this example since that was the highest rate bid among the lenders that remained on the loan (all the lenders make this amount even though some bid a lower interest rate than this). C remained on the loan because he placed the bid sooner than D. Note E made a smart move by bidding slightly lower than 15%. Many lenders bid in regular whole or half numbers, so bidding odd increments like .47 or .98 will often keep you on a loan while lenders with nearly identical but slightly higher rates get outbid.

So the question becomes: Is it good to bid early since that will keep you in line before someone else who bids the same rate?

The answer is: Not really. If you bid an odd number like XX.47 the chances of a significant number of others bidding the exact same number are slim. The more important consideration becomes whether or not the loan will fund. Many loans on Prosper end up not funding because there are currently more borrowers seeking loans than there are lenders with funds available (a good situation for lenders). The risk is that you will have your money tied up for several days on a loan that ends up not funding (once you have committed a bid to a loan it can not be withdrawn, and that money is no longer available for bidding on other loans).

So, bidding on a loan after it has reached >75% funded, or bidding on the last day on a fully funded loan increases the chances of being on a loan that will close fully funded. If a loan closes before being fully funded then the loan is cancelled and the money is returned to your account.

After a fully funded loan closes it goes into a verification process that can take 3-10 days before the loan is completed. During this time a loan can be cancelled if it does not meet the verification criteria. The most common reason for a loan not meeting verification is for failure to verify income. Prosper does not verify the income until the loan closes. Since this is a personal loan only personal income counts. One thing that you often see is someone who makes $40,000 per year has a spouse that makes $35,000 per year, so they put $75,000 for their income amount. This will fail verification because you can only include your income in the loan since the loan is being made to a single individual. The same is true for self employed people who put their business income rather than their personal income on the loan. Often, as a lender, you can spot this in the listing and realize that the loan is likely to not pass verification. If you don't want money tied up for a week on a loan that will end up being cancelled then it is wise to pass on those loans.