Monday, July 23, 2007

How does Prosper make money?

After understanding the concept behind Prosper and peer-to-peer lending, one of the questions people often have is: how does Prosper make money?

This is a very legitimate question. After all, if Prosper doesn't make money then it is a flawed business model and doomed to eventual failure. On the other hand, any money that Prosper does make is going to be coming out of the pockets of lenders or borrowers.

The fee structure at Prosper is pretty straightforward:

For borrowers there is a closing fee of 1% of the amount borrowed for AA-D credit grades, and 2% for E-HR credit grades. The minimum closing fee is set at $25. For non-electronic loan payments there is an additional 1% charge (this is an optional fee).

For lenders there is a 0.5% loan servicing fee for AA-A credit grades, and a 1% servicing fee for B-HR credit grades. These fees are deducted from each loan payment as they are received.

So, for an E or HR loan Prosper is earning a total of 3% of the loan amount, while for an A or AA loan Prosper's take is 1.5%.

The only additional fees are late payment fees (which are directly passed on to lenders), and a failed payment fee of $15 for cases where there are insufficient funds in the borrower's bank account.

I don't think these fees are unreasonable. The lender fees are similar to what you would see at a mutual fund, and less than you would pay for portfolio management at other financial institutions. For borrowers the fees are less than you would pay in closing costs for a loan at most banks. However, it is important that borrowers and lenders understand these fees. If you are a lender and want to make 10% on a B loan then you need to bid at least 11%, while on an A loan you could bid 10.5% to earn the same amount of interest. As a borrower you need to be aware that the amount requested is going to be reduced by the closing fee amount.

So, how much money does this earn for Prosper in aggregate? Here is a rough guesstimate:

Prosper has closed about 12,000 loans with a total dollar amount of $76 million. If Prosper earns between 1.5% and 3% per loan, that means they have grossed between $1.14 million and $2.28 million so far.

So, we have a rough idea of how much money Prosper makes in gross revenue. Since they are not a publicly traded company there is little information publicly available about their expenses. Many of their functions such as loan collections are outsourced. I would guess that the remaining major expenses are as follows:

  • Maintenance for keeping the site up and running.
  • Ongoing programming fees for new features and updates.
  • Marketing expenses including $25-$125 per new referral that joins Prosper.
  • Staff salaries (for verifications, customer service, management, IT, etc.)
  • My guess is that after factoring in these ongoing expenses, and the initial expenses for building the platform, Prosper has yet to earn a profit. However, this is often the case with young companies, and Prosper does have some strong venture capital backers that gave them some initial funding to work with. Also, Prosper has great growth potential as the leader in an industry that is expected to experience a lot of growth over the next few years.


    Tom said...

    Matt, interesting read.

    I suspect that another major expense for Prosper is to perform credit checks on new borrowers. As I mentioned in an earlier post, here are thousands of listings that go unfunded. On each one of these listings Prosper is paying Experian to check the borrower's credit. I'm not sure how much that costs but I've seen estimates of around $5 per pull.

    Earlier this month Prosper changed their policies so that they only check credit every 30 days instead of 20 if a borrower is re-listing. In the forums, Prosper Andrew said, "In the past, we would use a borrower's credit data until it was up to 20 days old, and past 20 days, we would pull a new credit profile for borrowers. Going forward, we will use credit data which is up to 30 days old." He added, "this is...a change that helps us reduce costs."

    There are some people that do not intend on getting a loan but just go through the borrowing process as a free credit check. Mandmboysfan said this in the forums, "I know I never really intend to borrow money from prosper, but I still check my credit grade every 30 days (used to do it every 20). I figure it is a free and easy way to make sure my identity hasn't been stolen (at least by someone who applied for an account that checked experian). I will probably sign up at lendingclub as well to monitor my transunion report. If zopa ever launches and uses equifax I will be all set."

    Any guesses on how much these credit pulls cost Prosper?

    Matt said...

    Not sure how much they cost. They only do pulls from Experian, so that will be less than if they were doing credit pulls from all three agencies. In aggregate this probably is a big expense for them. I wonder if that is the reason they charge a bigger closing fee on HR loans. Many HR loans don't fund, so there would be lots of expense for credit pulls on unfunded loans. Charging HR loans that do fund a higher closing fee might be helping make up some of that difference.

    Tom said...

    Another cost - identity theft. Prosper provides a 100% identity theft guarantee. "If a lender is the victim of a defaulted loan from a person who has committed identity theft, Prosper will repurchase the loan for the unpaid principal amount."

    I wonder how many loans Prosper ends up repurchasing and what the overall cost is.

    Matt said...

    Here is a list of 40 loans that they have repurchased:

    It looks like a total of almost $200,000 in repurchased loans. It is possible that if they can identify the people involved in the identity theft they may be able to go to court and recoup some of that money.

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