Payday loan guidance for borrowers

P2P loans start at $500 for Lending Club and $1000 for Prosper and typically take 2-3 weeks to complete. What if you don't need that much money, need it sooner, or cannot qualify for a P2P loan?

Many people who fall into these categories turn to payday loans. A payday loan (also called paycheck advance, payday advance or cash advance) is a small, short-term loan that is intended to cover a borrower's expenses for a week or two until payday.

Several months ago I found a listing on Prosper where a payday lender was looking for a $25,000 loan to help his business. I was intrigued that a payday lender would be seeking a P2P loan. I exchanged a few emails with him. He defended his business and explained how he is often the only option available to consumers with bad credit.

Many lenders on Prosper who loan to high risk or borrowers with low credit have faced high defaults and negative returns. Critics (including me) have sometimes blamed payday lenders for exploiting people's financial hardship for profit. Some of these payday borrowers ultimately look to consolidate multiple payday loans on Prosper or Lending Club. I wondered if payday lenders have high default rates and expensive collection efforts which require high fees to stay profitable.

According to a study by the FDIC Center for Financial Research, "operating costs lie in the range of advance fees" collected and that, after subtracting fixed operating costs and "unusually high rate of default losses," payday loans "may not necessarily yield extraordinary profits." Perhaps some payday lenders have difficulty producing positive returns after defaults and paying for the administrative overhead to collect outstanding loans.

I was recently contacted by a payday loan company called National Payday that was interested in advertising on PLR. After reviewing the site, I accepted their offer. They currently offer a free payday loan to first time borrowers. If you borrow $200 and pay back the full amount by your next payday there are no charges. Miss the payment, however, and you will be charged 25% of whatever you fail to pay. It is very important with payday loans to pay off the full amount promptly and then build an emergency fund so you do not have to borrow again.

The Federal Trade Commission provides the following guidance to individuals seeking a payday loan:

• When you need credit, shop carefully. Compare offers. Look for the credit offer with the lowest APR - consider a small loan from your credit union or small loan company, an advance on pay from your employer, or a loan from family or friends. A cash advance on a credit card also may be a possibility, but it may have a higher interest rate than your other sources of funds: find out the terms before you decide. Also, a local community-based organization may make small business loans to individuals.


• Compare the APR and the finance charge (which includes loan fees, interest and other types of credit costs) of credit offers to get the lowest cost.


• Ask your creditors for more time to pay your bills. Find out what they will charge for that service - as a late charge, an additional finance charge or a higher interest rate.


• Make a realistic budget, and figure your monthly and daily expenditures. Avoid unnecessary purchases - even small daily items. Their costs add up. Also, build some savings - even small deposits can help - to avoid borrowing for emergencies, unexpected expenses or other items. For example, by putting the amount of the fee that would be paid on a typical $300 payday loan in a savings account for six months, you would have extra dollars available. This can give you a buffer against financial emergencies.


• Find out if you have, or can get, overdraft protection on your checking account. If you are regularly using most or all of the funds in your account and if you make a mistake in your checking (or savings) account ledger or records, overdraft protection can help protect you from further credit problems. Find out the terms of overdraft protection.


• If you need help working out a debt repayment plan with creditors or developing a budget, contact your local consumer credit counseling service. There are non-profit groups in every state that offer credit guidance to consumers. These services are available at little or no cost. Also, check with your employer, credit union or housing authority for no- or low-cost credit counseling programs.


• If you decide you must use a payday loan, borrow only as much as you can afford to pay with your next paycheck and still have enough to make it to the next payday.

National Payday is a sponsor of PLR. If you are interesting in becoming a sponsor, email prosperlending@gmail.com.

Fed Chief estimates subprime fallout at $100,000,000,000

In comments to congress today, Federal Reserve Chief Ben Bernanke said the subprime fallout could result in as much as $100,000,000,000.00 in losses for lenders. That is a lot of zeros.

During the hearing, Ben Bernake said the "Federal Reserve is taking measures to protect borrowers." Then congressmen aggressively questioned him about whether the measures to protect the borrowers were being taken quickly enough.

The question I have is:

Why isn't anyone talking about what can be done to help the lenders?

It is, after all, the lenders that will be incurring the $100 billion dollars in losses. I know there are some predatory lenders out there and I don't have a ton of sympathy for some of them. But, I also find it hard to sympathize with borrowers who got into more debt than they could afford at terms they didn't bother to read. In the end, some borrowers will end up having to find a more affordable place to live, but a lot of lenders and investors will be left holding an empty bag.

It will be interesting to watch and see whether any of the subprime loan fallout spills over into higher defaults on subprime loans on Prosper. If so, should we be asking what we can do to help those HR borrowers that can't make the payments on those loans?

Prosper warns lenders of high risk credit grades

Prosperousland points out an interesting change in the bidding page for the riskiest credit grades. When you click to bid on E and HR credit grade loans you are now greeted with a large banner - Warning: Very low credit grade.

The disclaimer shows that E borrowers with 2 or fewer delinquent accounts have a default rate of 9.2% and E borrowers with 3 or more delinquent accounts have a default rate of 35.3%. High risk borrowers with 2 or fewer delinquent accounts have a default rate of 17.5% and high risk borrowers with 3 or more delinquent accounts have a default rate of 52.1%. This data is for loans with origination dates of Jun-Nov 2006 and as of Jan 2007.

There have been complaints in the forums that many lenders, especially new lenders, do not fully understand just how risky HR and E credit grades are. A lender who goes by the username thisguy has been the most vocal proponent of warning new lenders about the risk associated with E and HR borrowers. He has posted several messages such as this one, "If nothing else I still think there should be a 30 day ban from day 1 thru 30 of your lending life here where you are banned from bidding on HRs - then at least you will have had some time to build up your knowledge base, and see the 'reality' of the site." Other veteran leaders agree. In an open letter to Prosper in April Fred93, one of Prosper's largest lenders, accused Prosper of misleading lenders about potential returns and default rates.

This move by Prosper appears to be an attempt to respond to the criticism. It helps increase visibility of the likelihood of default on E and HR loans and will help new lenders fully understand the risk associated with lower credit grades.

While I think this is a great move for Prosper, it is also likely to make it harder for E and HR borrowers to get loans. As I mentioned in an earlier article, nearly 7 of 10 listings are from E and HR borrowers but very few of them get funded. Six months ago lenders aggressively funded low credit grade loans, but they have backed off due to the high default rate.

Analyzing the data using Prosper's Marketplace Performance, it appears that Prosper presented the most brutally honest, worse possible data. It also appears they included the rate adjustments in the default amount to come up with their percentages. If you move the range of dates forward or back the default rate gets slightly better or stays about the same.

Prosper lenders avoid high risk loans

Earlier this week I put together a list of all the top Prosper blogs. As I was reading, I came across an interesting post from January on Money Walks. The article, Blame the Lenders? Or the Borrowers?, showed that high risk and E-grade loans made up a full 80% of the listings at the time. Money Walks also discovered that lenders were allocating nearly 50% of funds to those risky credit grades. This surprised me and I decided to take a quick look at current open loans.

At the time of this writing there are 2554 open loans. 48% are high risk and 19% are E-grade. A full 67% of loan requests are from these risky credit grades - not quite as high as earlier this year but still very high.

So, are lenders funding these loans? Of the open loans I ran a quick search to see which ones have already been funded at least 75%. Only 8 of 1221 open high risk loans (<1%) are on their way to funding. Not much better for E-grade - 6 of 476 (also 1%). How about AA and A credit grades? 18 of 67 (27%) of open AA loans are at least 75% funded while 13 of 67 (19%) A loans meet the criteria. It appears that lenders have learned their lessons over the past months and are now avoiding high risk borrowers. The money is now flowing to those with good credit. Of course, many of these loans I looked at have just opened so the percentage is not representative of how many will be funded by the time the bidding closes. It does, however, allow us to compare the different credit grades.


The graph above shows the number of loans that are at least 75% funded compared to the number of open loans for that credit grade. Last week Matt explained why it makes good financial sense for some people to borrow from Prosper. Those with good credit and no home to borrow against can usually get a better rate through Prosper on an unsecure personal loan than they can through a traditional bank. It appears, however, that this demographic may be a very small minority on Prosper. Many of those seeking Prosper loans may be borrowers that can not obtain financing through other means. Many months ago, lenders on Prosper may have funded these loans but high default rates have caused changes to investing/lending habits.

It's also interesting to note the size of loans being funded to high risk borrowers. Of the 87 open listings that are at least 75% funded only 4 of them are over $20,000 - all to AA and A borrowers. The largest funded loan to a HR borrower is $10,000 (which one lender put up the full amount despite never bidding on anything but B or better in 58 previous loans - very odd.) Bottom line, if you want to be funded on Prosper today and especially if you want to borrow more than a couple thousand dollars, your chances are pretty slim if you are a high credit risk. It appears lenders have changed their investment patterns in accordance with good risk management tactics.

I realize that more complete statistical analysis can be done on closed loans and perhaps I will do that in a future post. It will be interesting to look at which credit grades have been favored by lenders over time.