When lending money on a peer to peer lending site such as Prosper or Lending Club you want to take every effort to mitigate risk while maximizing returns. One way to reduce risk is to lend to borrowers who are making smart financial decisions. Matt has discussed this issue several times on this blog. This is from his recent post about why a borrower with good credit might choose Prosper over a traditional bank:
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.
Lending Club has just released loan statistics from their first eight weeks in a post titled Facebook and Lending Club users are smart borrowers. A full 50% of borrowers are using Lending Club loans to refinance credit card loans or consolidate debt. This is good for borrowers and lenders. Borrowers who make smart financial decisions are less likely to default on their loans. Lending Club's blog has been focused on educating and attracting borrowers who are interested in improving their financial situation through smart choices.
I took a quick look at the current open listings. Currently there are 27 open listings on Lending Club. Of those, 10 (37%) are to consolidate debt or refinance higher interest rate loans. Some of the loans are difficult to classify based on the limited description. For example, which catagory would you put this in? "Loan to pay off high interest student loan I have." Is it education or refinancing? This description also raises some concerns like Matt mentioned above. Even though debt consolidation would ordinarily be a wise financial decision, refinancing student loans could raise a red flag. As Matt mentioned on his article about avoiding bankruptcies, "thanks to the federal government, student debt usually has generous interest rates, and can be financed over a long period of time which allows for low monthly payments." Listings like this on Prosper would generally draw questions from skeptical lenders. On Lending Club there is not an option to ask the borrower a question directly. Lending Club, however, does not allow borrowers with a credit score below 640.
Listings on Lending Club generally contain less information than Prosper. For example, one listing contains the title "education" but there is nothing additional offered in the loan description. It's 86% funded with 4 days remaining. While the loan descriptions on Lending Club and Prosper are interesting, lenders generally agree that risk is better assessed through verifiable statistics such as current delinquencies and credit grade. I'll quote Matt one last time, "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."