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Saturday, January 23, 2010
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Almost three years ago I discovered peer to peer lending, in the form of the then widely hyped Prosper.com. For a week or two I was enthusiastic on it as an investment, until I crunched enough numbers to decide it was not so exciting after all. In the meantime, I had put $1000 in ten $100 loan slices.
Loans on Prosper are three years in duration, so next week this little experiment will finally wind down. Assuming that I get the last $15.46 that is owed me, I will have received a grand total of $1029.50 over three years. A zero percent return is pretty lousy, but at least I have the solace that quite a few other things that I could have invested in in January 2007 would have done a lot worse.
But, as it turns out, breaking even makes me an above average lender on Prosper. According to the delightfully data laden Eric’s Credit Community, which tracks and analyses Prosper loan data, the average lender on the site has an ROI of –2.29%. Again, it could have been worse.
I found Eric’s from a post by Mark Gimein at Slate’s The Big Money, cleverly entitled You Are Unlikely To Prosper. That post has made a minor splash in some circles by making the case, with the use of actual data, that investing in Prosper has not really worked out for enthusiastic early adopters like me.
Prosper is incensed by this slander, yesterday calling for The Big Money to retract the post. They considered it to be "disappointingly inaccurate" and continued their response with such outstandingly lame counterpoints as:
Mr. Gimein states that 39% of loans that have had a chance to come to maturity (originated prior to 12/31/2006) have defaulted. What he doesn’t say is that the annual yield on these loans was 16% and the annual loss experienced by lenders was actually 20%, resulting in an annual average return of negative 4%. Although this return is negative, put in the context of the largest recession in generations, and the performance of other asset classes during the same time period, this paints a very different and more accurate picture of how lenders have fared on Prosper.
Mr. Gimein continues to use his flawed methodology to state that 54% of loans with an interest rate of 18% or greater have defaulted, leaving the impression that lenders on these loans have lost over half of the funds that they lent, and that losses ran roughly three times the interest rate on loans. Again Mr. Gimein is equivocating annual interest earned with cumulative default rates over a three year period. Lenders on these loans lost 10% on an annual basis, and while not positive, it’s a far cry from the 54% loss that Mr. Giemein flawed analysis leads the reader to believe.
In other words, sure people who invested with us are poorer now, but not that much poorer. And given the recent performance of the overall economy and consumer credit in particular, this really ain’t so bad.
Okay, those are valid points. I guess.
But read carefully and you see that Prosper is not saying that Gimein got facts wrong, only that by citing those facts he left the reader with a more negative spin than Prosper would like. 39% of loans written before 12/31/06 really did default. The best Prosper can say is that that is not as bad as it sounds. Inconvenient things, numbers.
Gimein’s piece ends with what I consider to be the most interesting facet of all this, that despite the relatively easy availability of quantitative evidence that the Prosper model is, at best, questionable, the media continues to happily shill for it as the next great thing. Gimein cites a recent MSNBC interview with the Prosper CEO and an article in The Washington Post. (To be fair, the Post’s item is mostly about what a good deal it is for borrowers.)
To this I will add that there is plenty of optimism about Prosper in the blogosphere, apparently founded on something other than actual data. For example, and I cite it only as one example of many, just last month The Digerati Life told us that "peer to peer lending offers a fresh, alternative way to invest your funds" and stated that Prosper had an average annual return of 7.06%.
For obvious reasons, I will refrain from saying that you would have to be crazy to invest in Prosper. But in hindsight I find myself wondering why I ever thought this could make sense. The basic pitch of peer to peer lending is that it takes the middleman out of the consumer lending process. That is, that individuals making loans directly to consumers is, somehow, a more efficient and better model than the tired old bank way.
What could we have possibly been thinking? Granted, it is pretty clear that in the middle of the last decade those professional loan officers did not do a very good job. But they screwed up by being too permissive, not by missing out on opportunities to lend to our trustworthy and wholesome peers. That is a mistake that, had you known about it in advance, would have made you want to stay far far away from making consumer loans.
I think that banks are generally pretty good at loaning money, if only for the Darwinian reason that banks that are bad at it do not last very long. Yet the fundamental premise of peer to peer lending is that amateurs like us can do it at least as well as the professionals.
I can take seriously the argument that ordinary individuals can compete successfully with the pros in stock investing. (I still think it is wrong, but I can listen to it without eye rolling.) But competing with pros in writing consumer loans? Really?
Loans on Prosper are three years in duration, so next week this little experiment will finally wind down. Assuming that I get the last $15.46 that is owed me, I will have received a grand total of $1029.50 over three years. A zero percent return is pretty lousy, but at least I have the solace that quite a few other things that I could have invested in in January 2007 would have done a lot worse.
But, as it turns out, breaking even makes me an above average lender on Prosper. According to the delightfully data laden Eric’s Credit Community, which tracks and analyses Prosper loan data, the average lender on the site has an ROI of –2.29%. Again, it could have been worse.
I found Eric’s from a post by Mark Gimein at Slate’s The Big Money, cleverly entitled You Are Unlikely To Prosper. That post has made a minor splash in some circles by making the case, with the use of actual data, that investing in Prosper has not really worked out for enthusiastic early adopters like me.
Prosper is incensed by this slander, yesterday calling for The Big Money to retract the post. They considered it to be "disappointingly inaccurate" and continued their response with such outstandingly lame counterpoints as:
Mr. Gimein states that 39% of loans that have had a chance to come to maturity (originated prior to 12/31/2006) have defaulted. What he doesn’t say is that the annual yield on these loans was 16% and the annual loss experienced by lenders was actually 20%, resulting in an annual average return of negative 4%. Although this return is negative, put in the context of the largest recession in generations, and the performance of other asset classes during the same time period, this paints a very different and more accurate picture of how lenders have fared on Prosper.
Mr. Gimein continues to use his flawed methodology to state that 54% of loans with an interest rate of 18% or greater have defaulted, leaving the impression that lenders on these loans have lost over half of the funds that they lent, and that losses ran roughly three times the interest rate on loans. Again Mr. Gimein is equivocating annual interest earned with cumulative default rates over a three year period. Lenders on these loans lost 10% on an annual basis, and while not positive, it’s a far cry from the 54% loss that Mr. Giemein flawed analysis leads the reader to believe.
In other words, sure people who invested with us are poorer now, but not that much poorer. And given the recent performance of the overall economy and consumer credit in particular, this really ain’t so bad.
Okay, those are valid points. I guess.
But read carefully and you see that Prosper is not saying that Gimein got facts wrong, only that by citing those facts he left the reader with a more negative spin than Prosper would like. 39% of loans written before 12/31/06 really did default. The best Prosper can say is that that is not as bad as it sounds. Inconvenient things, numbers.
Gimein’s piece ends with what I consider to be the most interesting facet of all this, that despite the relatively easy availability of quantitative evidence that the Prosper model is, at best, questionable, the media continues to happily shill for it as the next great thing. Gimein cites a recent MSNBC interview with the Prosper CEO and an article in The Washington Post. (To be fair, the Post’s item is mostly about what a good deal it is for borrowers.)
To this I will add that there is plenty of optimism about Prosper in the blogosphere, apparently founded on something other than actual data. For example, and I cite it only as one example of many, just last month The Digerati Life told us that "peer to peer lending offers a fresh, alternative way to invest your funds" and stated that Prosper had an average annual return of 7.06%.
For obvious reasons, I will refrain from saying that you would have to be crazy to invest in Prosper. But in hindsight I find myself wondering why I ever thought this could make sense. The basic pitch of peer to peer lending is that it takes the middleman out of the consumer lending process. That is, that individuals making loans directly to consumers is, somehow, a more efficient and better model than the tired old bank way.
What could we have possibly been thinking? Granted, it is pretty clear that in the middle of the last decade those professional loan officers did not do a very good job. But they screwed up by being too permissive, not by missing out on opportunities to lend to our trustworthy and wholesome peers. That is a mistake that, had you known about it in advance, would have made you want to stay far far away from making consumer loans.
I think that banks are generally pretty good at loaning money, if only for the Darwinian reason that banks that are bad at it do not last very long. Yet the fundamental premise of peer to peer lending is that amateurs like us can do it at least as well as the professionals.
I can take seriously the argument that ordinary individuals can compete successfully with the pros in stock investing. (I still think it is wrong, but I can listen to it without eye rolling.) But competing with pros in writing consumer loans? Really?
SmartMoney
http://www.smartmoney.com/spending/deals/peer-to-peer-lending-offers-solution-for-strapped-consumers-21978/#
Peer-to-Peer Lending Offers Solution for Strapped
Consumers
A YEAR AGO, Nicole Newberry was in a financial hole so deep that she had trouble making the minimum payments on her credit
cards. Worse, the then 22-year-old had gotten tangled up in the predatory cycle of payday loans. Every two weeks, when she
repaid the two loans she owed, she borrowed the money right back to pay for groceries and diapers for her two toddlers. Her
predicament was cruelly simple: "Each month, I was making all these minimum payments and getting nowhere," she says.
Then a co-worker told her about Prosper.com1, a peer-to-peer lending web site that facilitates loans between strangers.
Consumers seeking a loan list the details of how much they need and why, while those with cash to spare scour the listings and
make loans to the ones they choose. Generally, borrowers get lower interest rates than they would with a bank or credit card, while
lenders can earn better returns than they would in a money market or savings account.
Within 10 days of posting on Prosper, Newberry received a $9,000 loan at 19%: Enough to pay off the pesky payday loans and all
her credit cards, which at that time carried 25% to 27% interest rates. As a result, her monthly payment dropped significantly, to
$330 from $800 before consolidation. Her credit score, once a subprime 580, is now 680 and steadily rising. And then there's the
1,800-square-foot icing on the cake: Three months ago, Newberry purchased her first home, a four-bedroom house in Sacramento, Calif.
With the surging popularity of peer-to-peer lending sites, feel-good stories like Newberry's are becoming increasingly common.
Since its launch in February 2006, Prosper.com has facilitated $90.5 million in loans among nearly 440,000 individuals. LendingClub.com
LendingClub.com2, which launched in May exclusively for users of social-networking site Facebook, opened up its services to all
consumers in mid-September. Now the site has 20,000 users and has handled more than $1 million in loans. Starting Oct. 15C, ircleLending.com
CircleLending.co3m, which sold a majority stake in the company to Virgin USA in May, re-brands itself as Virgin Money. The site
manages more than $200 million in loans between friends and family.
Eliminating the bank or credit-card issuer as the middle-man isn't currently the norm, but it's gaining momentum, says Christine
Barry, research director of Aite Group, a financial industry research firm. The credit crunch and soft housing market combined have
all but killed the idea of using home-equity loans to refinance high-interest credit-card debt and homeowners looking to refinance
high-interest mortgages are unable to do so if they have less-than-pristine credit records. And small-business loans, always hard to
get from traditional banks, have pretty much dried up.
The result: People are seeking financing from, well, other people. At Virgin Money, loan volume in the past six months has been
growing twice as fast compared with the pace last year, according to Asheesh Advani, Virgin Money's CEO. (This is also partly
due to the acquisition of CircleLending by Virgin USA, he notes.) At Prosper.com, $62.1 million in loans changed hands
year-to-date, compared with only $16.8 million during the same period last year.
But the allure of peer-to-peer lending goes beyond better interest rates and improving one's bottom line. These web sites have
become somewhat of a mix of Match.com, Facebook and eBay, with emphasis as much on social networking as on closing a deal.
Being part of a group, whether it's an alumni association, employees of a specific company or simply being a friend of a friend,
plays a big role. At Prosper, users can create groups that, based on members' repayment history, receive star ratings and can
help borrowers get lower rates. At LendingClub, lenders pick borrowers based not only on their credit profile, but also on their affiliations.
"Peer-to-peer lending reminds me very much of the credit union model," says Aite Group's Barry. "You're usually lending to people
that belong to the same kind of affinity group. There's a certain degree of trust."
And then there's the fuzzy feeling of helping ordinary people fulfill their financial goals, whether it's getting out of debt, fixing a roof
or purchasing a dream wedding dress. "You, as the lender, can feel like Jimmy Stewart [in the movie "It's a Wonderful Life"] and
invest in people who you know, and fight the evil banks," says Andrew Nelson, a 48-year-old freelance writer in Alpine, Texas, who
has so far loaned more than $20,000 to more than 500 people on Prosper.com. When searching for borrowers, Nelson says he
looks as much at their "numbers" — a borrower's credit rating, loan-to-income ratio and repayment history on other loans — as the
stories behind them. "If I trust the story, I'll lend the money," he says.
To be sure, peer-to-peer lending doesn't come without risks. For lenders, the biggest danger is default. Of the $3 million lent
through Prosper.com in September 2006, for example, $300,000 in loans have already defaulted and more than $200,000 are two
or more months late, according toW iseClerk.com4, a web site that tracks Prosper.com activity. Default on mortgage loans taken
through Virgin Money is impressively low — 0.5% — but that's because most troubled borrowers choose to restructure loans, for
example by tacking missed payments onto the unpaid loan balance. Because their lenders are close friends or family members,
"people restructure all the time," Advani says.
For borrowers, meanwhile, there's no guarantee they'll find the money they need. Generally, the basic principle of lending applies
Published October 15, 2007
here as well: The lower your credit score, the lower your chance of getting financed. (Both Prosper.com and LendingClub.com
employ letter grades to assess borrowers' credit worthiness, based mainly on credit scores.) According to WiseClerk.com, of the
14,534 Prosper.com loan listings for borrowers with a "C" rating — that's for borrowers with credit scores between 640 and 679 —
only 2,668, or 18%, have been funded. Of the 4,608 "AA"-borrower listings, meanwhile — "AA" are borrowers with scores of 760 or
higher — 1,557, or 33%, have been funded.
To make sure her $9,000 loan request got noticed, Newberry shared as much personal information as she felt necessary about
why she needed the money and how she would repay them. She even included photos of her with her children and listed the
grades for the college classes she attends. She patiently and truthfully answered all questions from potential lenders. "You can't be
rude or defensive," she says. "You have to put all your business out there, be honest, and it'll pay off."
Tips for navigating peer-to-peer lending sites
Borrowers
1. Be honest. Don't withhold the details when composing your listing. Be specific about why you need the money
and how you'll pay the loan back. Break down your current debts and other monthly expenses and income, says
Nelson, the lender on Prosper.com. And don't worry: Sensitive information, such as your Social Security number
and full name, isn't published.
2. Pay back responsibly. Peer-to-peer lending services hire collection agencies if you fall behind on a payment.
Prosper.com does so as soon as you are more than 30 days late. More importantly, they report to the credit
bureaus. "This is not a free lunch," says Greg McBride, senior financial analyst at Bankrate.com. "It's something you
have to treat very seriously."
3. Factor in fees. These services aren't free. At Prosper.com, you'll pay between 1% and 2% and at
LendingClub.com, 0.75% to 2% of the loan balance, depending on your credit grade. (No fees are due if your loan
doesn't get funded.) Virgin Money charges a one-time fee between $249 and $2,299, depending on the extent of
services received.
Lenders
1. Think like an investor. Before plunging in, make sure you understand the logistics of the peer-to-peer site of
your choice. Each site has its own grading method for borrowers' creditworthiness, for example. (Prosper's credit
grades are here5, LendingClub's, here6.) Lower credit grades command higher interest rates, but the risk is also
higher. When picking borrowers, it helps to think like an investor. Diversify among different borrowers. If you have
$1,000, for example, split that among 10 or even 20 borrowers. Sure, $50 per person may sound like peanuts, but
that's exactly how most peer-to-peer loans get funded. Also, diversify among credit grades. "You can put some
money into the high-risk category, but then put some into the less-risky borrowers who are paying lower rates,"
McBride advises.
2. Factor in fees. Prosper.com lenders pay a 0.5% to 1% annual servicing fee, based on the balance of the loan
outstanding. LendingClub.com charges 1% of all payments received each month. Should a loan go to collections,
you will also be responsible for the collection agency's fees.
3. Don't lend money you'll need. The loans are generally paid over three years, so make sure you don't lend any
money you'll need soon. Think of it as a CD, but one where your investment isn't guaranteed.
1http://www.prosper.com/
2http://www.lendingclub.com/home.action
3http://www.circlelending.com/
4http://www.wiseclerk.com/
5http://www.prosper.com/help/topics/borrower-credit_grades.aspx
6https://secure.lendingclub.com/info/how-we-set-interest-rates.action
http://www.post-gazette.com/pg/07252/815600-28.stm
Peer-to-Peer Lending Offers Solution for Strapped
Consumers
A YEAR AGO, Nicole Newberry was in a financial hole so deep that she had trouble making the minimum payments on her credit
cards. Worse, the then 22-year-old had gotten tangled up in the predatory cycle of payday loans. Every two weeks, when she
repaid the two loans she owed, she borrowed the money right back to pay for groceries and diapers for her two toddlers. Her
predicament was cruelly simple: "Each month, I was making all these minimum payments and getting nowhere," she says.
Then a co-worker told her about Prosper.com1, a peer-to-peer lending web site that facilitates loans between strangers.
Consumers seeking a loan list the details of how much they need and why, while those with cash to spare scour the listings and
make loans to the ones they choose. Generally, borrowers get lower interest rates than they would with a bank or credit card, while
lenders can earn better returns than they would in a money market or savings account.
Within 10 days of posting on Prosper, Newberry received a $9,000 loan at 19%: Enough to pay off the pesky payday loans and all
her credit cards, which at that time carried 25% to 27% interest rates. As a result, her monthly payment dropped significantly, to
$330 from $800 before consolidation. Her credit score, once a subprime 580, is now 680 and steadily rising. And then there's the
1,800-square-foot icing on the cake: Three months ago, Newberry purchased her first home, a four-bedroom house in Sacramento, Calif.
With the surging popularity of peer-to-peer lending sites, feel-good stories like Newberry's are becoming increasingly common.
Since its launch in February 2006, Prosper.com has facilitated $90.5 million in loans among nearly 440,000 individuals. LendingClub.com
LendingClub.com2, which launched in May exclusively for users of social-networking site Facebook, opened up its services to all
consumers in mid-September. Now the site has 20,000 users and has handled more than $1 million in loans. Starting Oct. 15C, ircleLending.com
CircleLending.co3m, which sold a majority stake in the company to Virgin USA in May, re-brands itself as Virgin Money. The site
manages more than $200 million in loans between friends and family.
Eliminating the bank or credit-card issuer as the middle-man isn't currently the norm, but it's gaining momentum, says Christine
Barry, research director of Aite Group, a financial industry research firm. The credit crunch and soft housing market combined have
all but killed the idea of using home-equity loans to refinance high-interest credit-card debt and homeowners looking to refinance
high-interest mortgages are unable to do so if they have less-than-pristine credit records. And small-business loans, always hard to
get from traditional banks, have pretty much dried up.
The result: People are seeking financing from, well, other people. At Virgin Money, loan volume in the past six months has been
growing twice as fast compared with the pace last year, according to Asheesh Advani, Virgin Money's CEO. (This is also partly
due to the acquisition of CircleLending by Virgin USA, he notes.) At Prosper.com, $62.1 million in loans changed hands
year-to-date, compared with only $16.8 million during the same period last year.
But the allure of peer-to-peer lending goes beyond better interest rates and improving one's bottom line. These web sites have
become somewhat of a mix of Match.com, Facebook and eBay, with emphasis as much on social networking as on closing a deal.
Being part of a group, whether it's an alumni association, employees of a specific company or simply being a friend of a friend,
plays a big role. At Prosper, users can create groups that, based on members' repayment history, receive star ratings and can
help borrowers get lower rates. At LendingClub, lenders pick borrowers based not only on their credit profile, but also on their affiliations.
"Peer-to-peer lending reminds me very much of the credit union model," says Aite Group's Barry. "You're usually lending to people
that belong to the same kind of affinity group. There's a certain degree of trust."
And then there's the fuzzy feeling of helping ordinary people fulfill their financial goals, whether it's getting out of debt, fixing a roof
or purchasing a dream wedding dress. "You, as the lender, can feel like Jimmy Stewart [in the movie "It's a Wonderful Life"] and
invest in people who you know, and fight the evil banks," says Andrew Nelson, a 48-year-old freelance writer in Alpine, Texas, who
has so far loaned more than $20,000 to more than 500 people on Prosper.com. When searching for borrowers, Nelson says he
looks as much at their "numbers" — a borrower's credit rating, loan-to-income ratio and repayment history on other loans — as the
stories behind them. "If I trust the story, I'll lend the money," he says.
To be sure, peer-to-peer lending doesn't come without risks. For lenders, the biggest danger is default. Of the $3 million lent
through Prosper.com in September 2006, for example, $300,000 in loans have already defaulted and more than $200,000 are two
or more months late, according toW iseClerk.com4, a web site that tracks Prosper.com activity. Default on mortgage loans taken
through Virgin Money is impressively low — 0.5% — but that's because most troubled borrowers choose to restructure loans, for
example by tacking missed payments onto the unpaid loan balance. Because their lenders are close friends or family members,
"people restructure all the time," Advani says.
For borrowers, meanwhile, there's no guarantee they'll find the money they need. Generally, the basic principle of lending applies
Published October 15, 2007
here as well: The lower your credit score, the lower your chance of getting financed. (Both Prosper.com and LendingClub.com
employ letter grades to assess borrowers' credit worthiness, based mainly on credit scores.) According to WiseClerk.com, of the
14,534 Prosper.com loan listings for borrowers with a "C" rating — that's for borrowers with credit scores between 640 and 679 —
only 2,668, or 18%, have been funded. Of the 4,608 "AA"-borrower listings, meanwhile — "AA" are borrowers with scores of 760 or
higher — 1,557, or 33%, have been funded.
To make sure her $9,000 loan request got noticed, Newberry shared as much personal information as she felt necessary about
why she needed the money and how she would repay them. She even included photos of her with her children and listed the
grades for the college classes she attends. She patiently and truthfully answered all questions from potential lenders. "You can't be
rude or defensive," she says. "You have to put all your business out there, be honest, and it'll pay off."
Tips for navigating peer-to-peer lending sites
Borrowers
1. Be honest. Don't withhold the details when composing your listing. Be specific about why you need the money
and how you'll pay the loan back. Break down your current debts and other monthly expenses and income, says
Nelson, the lender on Prosper.com. And don't worry: Sensitive information, such as your Social Security number
and full name, isn't published.
2. Pay back responsibly. Peer-to-peer lending services hire collection agencies if you fall behind on a payment.
Prosper.com does so as soon as you are more than 30 days late. More importantly, they report to the credit
bureaus. "This is not a free lunch," says Greg McBride, senior financial analyst at Bankrate.com. "It's something you
have to treat very seriously."
3. Factor in fees. These services aren't free. At Prosper.com, you'll pay between 1% and 2% and at
LendingClub.com, 0.75% to 2% of the loan balance, depending on your credit grade. (No fees are due if your loan
doesn't get funded.) Virgin Money charges a one-time fee between $249 and $2,299, depending on the extent of
services received.
Lenders
1. Think like an investor. Before plunging in, make sure you understand the logistics of the peer-to-peer site of
your choice. Each site has its own grading method for borrowers' creditworthiness, for example. (Prosper's credit
grades are here5, LendingClub's, here6.) Lower credit grades command higher interest rates, but the risk is also
higher. When picking borrowers, it helps to think like an investor. Diversify among different borrowers. If you have
$1,000, for example, split that among 10 or even 20 borrowers. Sure, $50 per person may sound like peanuts, but
that's exactly how most peer-to-peer loans get funded. Also, diversify among credit grades. "You can put some
money into the high-risk category, but then put some into the less-risky borrowers who are paying lower rates,"
McBride advises.
2. Factor in fees. Prosper.com lenders pay a 0.5% to 1% annual servicing fee, based on the balance of the loan
outstanding. LendingClub.com charges 1% of all payments received each month. Should a loan go to collections,
you will also be responsible for the collection agency's fees.
3. Don't lend money you'll need. The loans are generally paid over three years, so make sure you don't lend any
money you'll need soon. Think of it as a CD, but one where your investment isn't guaranteed.
1http://www.prosper.com/
2http://www.lendingclub.com/home.action
3http://www.circlelending.com/
4http://www.wiseclerk.com/
5http://www.prosper.com/help/topics/borrower-credit_grades.aspx
6https://secure.lendingclub.com/info/how-we-set-interest-rates.action
http://www.post-gazette.com/pg/07252/815600-28.stm
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