So You Wanna Be A Banker...
Coolmom14 is a struggling single mom asking for an $18,000 loan to pay off high interest credit cards.
Craigny needs a $25,000 loan to buy a profitable coffee shop in NY.
Nurse202 would like $4,000 to pay for cosmetic surgery.
These are the candidates on Prosper.com you can choose from if you've ever wanted to be a benefactor to those who are down-and-out on their financial luck. These people typically have below optimal credit scores, so find it difficult to get loans elsewhere. You can charge a significant interest rate to get a good return on investment, but don't bid too high or else you'll lose out. It's a reverse auction system so that at the end of the auction, the bids with the lowest interest rates "win" the loan. A loan will have literally dozens of lenders because lenders will try to diversify their risk by loaning out small amounts of money to more people. For example, if you have $5,000 to invest, instead of giving the whole $5,000 to one borrower, you might give out $50 loans to 100 people.
Started more than two years ago by the former CEO of E-Loans, the principle idea behind Prosper.com is community responsibility of peer-to-peer lending.
"Prosper's founding principle is that people from close communities act more responsibly towards each other. Prosper leverages this powerful concept of community responsibility and applies it to person-to-person lending—resulting in better interest rates for people that borrow and lend."
People can join groups to leverage a better interest rate. These groups are supposed to use peer pressure as a tool to prevent defaults. If you are late on a payment, the group members will be contacted and asked to encourage payment. Also, a group leader can be assigned and will have monetary incentives given by Prosper to keep all the group members' accounts current.
Shopping for loans, eBay style. This is how it works.
1. Borrowers request 3 year loans up to $25,000 by posting listings indicating the amount they want to borrow and the maximum interest rate they will pay.
2. Lenders browse the listings and make selections based on the borrower's credit history, debt profile, and other financial factors (verified by Prosper). Also, cute pictures and personal stories are included.
3. Lenders bid by indicating a minimum interest rate they'll accept, and how much they can offer.
4. Prosper matches lenders with borrower by choosing the lowest bidders for each loan. They handle the money transfers from lender(s) to borrower.
5. Payment is taken from borrower's bank account each month, and deposited back to lenders' accounts.
What's in it for Prosper?
1. Prosper charges the buyer a 1%-2% closing fee.
2. Prosper charges lenders a 0.5%-1% annual loan servicing fee.
What happens if the borrower skips town?
This is where the "diversify your risk" comes in. There is no guarantee that you will get your money back. Prosper will give you the tools to assess the risk of the borrower. Of course, the higher the risk, the higher the interest rate you can charge. If a borrower misses a payment, Prosper will contact the borrower. After 15 days, Prosper will contact the borrower's friends and group leader (if any). After 30 days, Prosper will hire a collection agency. Late fees are incurred in the meantime and passed along to the lenders, although that only matters if the borrower decides to bring the account back to current and pay those late fees. Otherwise, the lenders will receive whatever the collection agency can collect and/or a debt buyer pays to buy out the loan. Prosper will report the activity to credit agencies, negatively impacting borrower's credit. The borrower will also not be allowed to borrow on Prosper again.
Is it right for you?
Like most investments you can make with your money, there are risks. With peer-to-peer lending, though, the risks feel more personal. Do you feel comfortable that a regular joe who has had some credit problems be willing and able to pay back your loan? But perhaps this type of investment is also less intimidating, more manageable, and more fun, than trying to trade stocks or funds.
Being able to read the performance stats is key to assessing an accurate risk and expected ROI. Keep in mind that it takes 6 months to a year for a loan to be labeled a default. Considering all the loans on Prosper are 3 year loans, it remains to be seen exactly how many of their loans will ultimately be paid off in full.
What are other people saying about it?
Mighty Bargain Hunter talks about cancelled loans.
Lendingstats give 10 tips to lenders.
My Money Blog analyze the drop in net returns as defaults rise.
Blogging Away Debt interviews pensioner, the Prosper lender with the most money invested.
Lazy Man And Money writes about his experience with Prosper after 16 months.
Other options in the marketplace!
EBay purchased MicroPlace and Virgin USA bought CircleLending. Their deep pockets will allow them to compete seriously with the current giant Prosper and UK's Zopa.com as well (planning to enter U.S. market any day now.