Tuesday, June 26, 2007

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.


tom said...

Very interesting. Awhile back you said this on the forums, "I look at verified stats, and things that the group leader can vet. Something in the listing could encourage me not to lend, but I don't think anything written in the listing could get me to fund a listing that I wouldn't fund based on the verified stats alone."

This post helps elaborate on what I think you meant in that earlier post.

tom said...

I just ran across an interesting comment about discrimination by lenderguy in the forums. He mentions the fact that Prosper is actually the lender and those investing money in Prosper are purchasing the loans. I wonder how that complicates compliance with federal lending laws.