Friday, June 15, 2007

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.

8 comments:

tom said...

Matt - great bidding tutorial. This is must read material for any new lender. Actually, any lender period. There were a bunch of surprises in this article for me. I hadn't considered how bidding on a loan that might not get funded ties up your money for several days.

tom said...

Do you use the watch feature to watch auctions? How does that work for you?

Matt said...

Yes, I do use the watch feature. This makes it easy to go back to listings that you were interested in. If you set up auto-funding you can also set that to include only those loans on your watch list, or explicitly exclude loans on your watch list.

tom said...

I just realized that this results in some pretty funny loan amount. RE-BuyandSell has bid on 11 loans. He won 1 loan and it must have just barely won part of his bid. Total amount loaned out - $0.83.

See his profile here:

http://lendingstats.com/memberProfile?lenderId=RE-BuyandSell

Anonymous said...

I think you've missed a very key point, which is the concern that you may be tieing up your money in a loan that won't fund, is so widespread that it is creating a type of hysteria on Prosper. If a Group Leader 100% funds a loan from the get go, assuming he picked any type of reasonable loan, that is on a set schedule, he is going to get bid out of the loan before it ends, and he is guaranteed a profit, he ends up with no money in the loan, but gets the group leader rewards. This is called a 'pump and dump'...but it demonstrates just how concerned Prosper lenders are, to always bid on a loan that is going to get funded. Good loans are going unfunded, and bad loans are getting bid on competitively, because of the pump and dump. I was disappointed in your article, because sniping a loan is a good idea on prosper. Right now, if you are a group leader, doing the pump and dump makes sense. If you are not, sniping a good loan at the last second, is the best strategy. You get the loan, at the highest rate, and pretty much all to yourself. You have to have money to do this. To spread your risk around, when you are putting thousands on a single loan, means you have playing with tens of thousands. But you have to do, group dynamics on Prosper are so incredibly bad right now, you don't want to bid on only loans that are going to be funded...the competitive loans may not be the best loans.

Matt said...

You make a good point. Pump and dump loans have been a significant concern on Prosper, and the problem really only exists because of the group leader reward structure. To discourage this, there are some lenders that have stopped bidding on loans where the group leader is taking a reward.

Funding the entire loan at the last minute is a good option if you have tens of thousands of dollars to lend out, but for the smaller investors that is not an option.

Anonymous said...

"Pump and Dump" is no longer an issue (December 2008) as prosper no longer gives a kick-back to group leaders for funded loans.

The downside to bidding early is that it ties up your money. But it is not much of a downside, at least financially. The interest lost at bank rates is just a few cents on a few hundred dollars over a few days. The bigger downside is the time it takes to keep researching loans that end up not funding. For me it is really more of a time issue than a money issue.

The upside to bidding early is that it may help the loan get funded. Many peopel don't bid until it is funded or looks sure to do so. If no one ever bid early.....

A finer point to timing is that because so many people are determined to only bid on funded loans that loans that fund too early almost always get bid down way lower than is justified by any sane estimate. If you just cruise the ending loans and look for the early funded ones you will probably have a losing prtfolio due to bidding too low to ge in on all of these already funded loans. Optimun is to bid on a loan that does fund but no too soon prior to the end of bidding.

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