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.

3 comments:

tom said...

Thanks Matt for answering this question. I was wondering the same thing. I like how you suggest using the loan listing to determine if the loan makes sense. This can probably help a savvy lender avoid potential defaults.

Ryan said...

Matt,

Gret points, and I really appreciate you digging up those rates on loans...starts to put things into perspective. I've been a lender on prosper for over a year now and had a great experience. On the lending side, I think our perception is further skewed by our own situation. I personally have great credit, money to lend, etc. Any balance I have on a credit card is at a 0% interest rate...but there are many out there with incredible credit card rates - 20, 25 even 30%. Prosper can provide alot of help to people in situations like this.

Ryan McDermott

harry polle said...

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