Friday, June 15, 2007

An introduction - lending through Prosper

Grameen Bank and its founder, Muhammad Yunus, won the Nobel Peace Prize in 2006 for their work making small loans to poor people with big dreams. Prosper is a website that tries to extend the microcredit idea via the web to all people, including but not just limited to the very poor. It's been called the eBay of Loans by Forbes Magazine, the #1 website of the year by Time Magazine and has received plenty of other rave reviews. Prosper describes their service here:

The way Prosper works is intuitive to people who have used eBay. Instead of listing and bidding on items, people list and bid on loans using Prosper's online auction platform. People who want to lend set the minimum interest rate they are willing to earn and bid in increments of $50 to $25,000 on loan listings they select. People who lend can easily diversify using "standing orders", which automatically make many small loans to different borrowers.

Although it may seem somewhat risky, Prosper takes many more steps than eBay to prevent fraud. Everyone's identity is verified. Credit scores are checked. Those borrowing money basically go through the same rigid process required by any normal lender. Monthly payments are made by automatic withdraw from the borrowers savings account. So far Prosper has been very successful with over $67,000,000 in loans. It provides loans to people who need it at a lower interest rate than they would be able to get through a bank or credit card and provides lenders (you) a higher interest rate than they might get through a savings account, certificate of deposit, or other investment.

My brother Matt has been lending money on Prosper for nearly a year. He's careful about who he lends money to. Mostly he loans money to people with AA credit ratings. So far he's earning more than an 11% return on his money. None of his borrowers have been late with a payment. This is his lending profile.

Some people choose to lend money to people with poor and high risk ratings. Although the average interest rates can be as high as 26%, the default rates are also quite high for E and HR. Prosper reports defaults to the credit agencies and hires a collection agency, just like a normal bank or credit card company would.

With a careful investment strategy, it looks like Prosper may provide good returns with managable risk. Here are some of Matt's lessons learned from his months of studying and investing on Prosper. He has posted these on the Prosper Forums:

Its up to the lenders to read the text. I don't rely on that for the loan though. 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. I am happy with Prosper overall. (forum post - Would you stop lending if...)

No lates for me yet, but I enjoy reading these threads to see what to avoid. So far I am learning to avoid:

  • New business Ventures
  • People with high number of inquiries
  • Nurses who can't spell Nurse
  • Real Estate Ventures
  • All HRs and Es
  • People going through divorces
  • Georgia
  • Autofunding loans listed for a short time period
  • People who should be able to get more traditional financing (for something like a car purchase)
  • Anyone who has an abnormally low interest rate just because of a really nice looking photo
Anything I am missing on my list? I am sure some loans will still default for me, but just trying to learn from the collective experience out there. (forum post - The official 1 month late loan club...)

Shameless plug here. Prosper just announced a new referral program where they give $25 to both parties when you invite a friend to the program. If you decide to start up you should use this referral link to sign up so that you start of with an extra $25 in your account. Of course, I don't mind the $25 either. :) Details about the referral program.

This referral program reminds me of PayPal. They had amazing growth when they offered a free $5 to both parties when you refered a friend. That's when I signed up. It will be interesting to see how Prosper grows with this new referral program.

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