Subscribe to this BlogFeel thankful about losing money
My colleague Alexis Jeffries and I had fun reporting a recent story called "Five Ways To Pump Up Your Income," which ran in the December 2009 issue of MONEY. Who couldn’t use some ideas right now on how to make more dough?
As Alexis recently blogged, many of the ideas we came up with didn’t make it into the final piece. But there’s an idea that did make it into the article — lending money to friends, families and strangers through so-called peer-to-peer networks — that had a surprising aspect that we didn’t cover in the piece. What we learned was this: People who lend money directly to others in need feel a sense of satisfaction that goes well beyond the interest they earn — or don't earn — on the money they lend.
The idea behind sites like Prosper.com, Lending Club and Virgin Money is that peer-to-peer lending can be both financially and socially rewarding. The credit crunch has made it tougher for people to borrow money, and if you’ve got cash, you can lend it out for a higher rate than you’re getting in a bank account earning 0.5% or less today. Loans typically are capped at $25,000 and borrowers must meet certain minimum credit scores.
Now, there are some people who argue that the average returns you get on the money lent out are overstated. And the SEC cracked down on the lending clubs last year, deeming their offerings investments that must be regulated by the SEC. Since these sites have only been around a few years, it remains to be seen how the business model will hold up during these economically difficult times. But when I spoke to people who were actually lending money, I was surprised to hear how much satisfaction they got just from making the loans, even if the borrower defaulted on the loan.
One man I interviewed, a Chicago-area tech sales executive named Jack Reidy, lent $10,000 to 100 borrowers with varying credit scores starting in May 2008 (the loans have three-year terms). Reidy was first attracted to the idea after reading an article in BusinessWeek about Prosper. Fed up with his savings earning less than 1% at the bank, he decided to give it a whirl. “I like the idea of helping others in need,” he told me. Out of Reidy's 100 loans, 75 are being repaid on schedule, 16 are paid off and nine are in default. “A lot of the people in the higher risk categories I gave money to are students," he said. "I thought I’d be upset if someone didn’t pay, but I consider it a gift now.” And how is he doing on his investment? He had hoped to earn 17% but he’s averaging 8%. “I went into this aiming for a higher return, but I’m averaging 8% on the money I invested," he said. "That’s a lot better than what I was earning in my bank account, and I’m helping people. So I’m pretty happy.”
Not everyone is going to feel good about losing money, and this should only be done with money that you can afford to lose. But we’ve all lent money to family and friends without expecting to get the money back — and certainly without any interest. Which made me wonder: Just how many people out there who are lending money this way are feeling good about it and earning a good return?
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I started lending on Prosper in mid-2006… first I simply liked the idea of investing directly in other people… then when my stock portfolio tanked last year, I wished I had more invested on Prosper, which was netting me 5.5% on my $5k investment. My takeaway is that people will start realizing that Prosper / peer lending should be part of a diverified investment strategy.
Starting in Feb 2007 I loaned out $33,000 on Prosper. This totaled 624 loans ranging from $50 to $200. After about a year I realized my lending strategy was seriously flawed and at that point tightened up my requirements considerably. Still, even after this 17% of my "good" loans defaulted. So far 138 of the 624 loans I made have defaulted with no end in sight. A seemingly endless string of lates keeps on coming. But I have noticed a drop off in defaults after loans reach an age of around 20 months. All in all Prosper has been an interesting experiment and I have learned a lot about human nature. Would I do it again? Hell NO!!! Making unsecured loans to complete strangers over the internet is a BAD IDEA.. what the hell was I thinking?
Unfortunately, today it is socially acceptable to walk away from your obligations. In the future, it is only going to get worse. This peer to peer borrowing is insane. Bank rates might be low, but they are guaranteed and they are fdic insured……
Prosper is about as shady of a company as you can imagine. Approximately 40% of all loans on Prosper default. The company is perhaps best known for making unilateral, retro-active chages to their legal agreements, failing to honor it's re-purchase guarantee of ID-theft loans – and their utter failure to collect from delinquent borrowers or pursuing available legal avenues to go after fraudulent borrowers. Do your reserch before you put money into this.
I started lending on Prosper almost 3 years ago because of an article in Money Magazine, and am very, very sorry that I did so. I stopped lending 2 years ago because the company repeatedly acted (and acts) to the detriment of lenders. Experian estimated that my ROI would be 14.59% on what was a fairly conservative profile; in reality, my ROI is 1.4% and continuing to drop. I have NO satisfaction from feeling ripped off. Avoid Prosper like the plague.
Prosper loans last 3 years.
Lenders have a 1 year honeymoon period as most borrowers manage to pay that long. Then they stop paying and file bankruptcy.
I now expect to lose at least 10% of the money I loaned. So much for *making* 10%
Peer lending is new and not well understood – I earn 10+ percent on hundreds of thousands of dollars, and i know of several poeople with multiple millions also earning 10%+.
Before diving in, there are three things every investor should understand
1) Defaults are part of the return formula, just like they are for banks. Peer Lending is better called bank disintermediation, which lets individuals earn money the way banks do. This means that if you loan people money at 17%, 5-7% of these people will default, resulting in an expected return of around 10%. The article mentions this scenario as if the investor is dissapointed – he's just uninformed.
2) Diversification is an absolute must – ideally investors should have more than 400 notes. No bank would ever make just one big loan to one borrower, they loan to thousands of people, which means they can get predictability of defaults based on 50 years and 50 million credit histories. in this way, 17% loans can predictably provide a 10% return. I should note that I only have this experience with Lending Club, and I have seen Prosper results which are not as good.
3) Defaults come mostly in the first 18 months of a 36 month loan. So year one, you are likely to see about 10% return out of 17% loans, year two, you could see as low as 4-7% returns, but by year three, your remaining borrowers are very unlikely to default, providing the entire 17% for the last year, netting a three average of 10%
DrBillToth says; I too hope this trend continues and I believe that most entrepreneurs get launched thanx to the openness and generosity of friends and family that believe in the person and their willingness to "Commit beyond Convenience"
Live with Intention,
DrBillToth.com/blog
John, banks provide a service, for a fee, that consumers need in order to go about their daily lives and participate in the marketplace. Without a central banking system, you cannot have a civilized society. I encourage you to read up on the history of modern banking going back to ancient Rome. I think if you had a fundamental understanding of how it actually worked and didn't rely on regurgitating partisan, populist rhetoric, you may actually be able to make an intellegent post worth reading.
As someone who lent a total of $1,000 to about 20 people on Prosper, I can say it was an incredible learning experience. Watching people with good credit default, bad credit default, people promising to make payments "no matter what" defaulting…
It taught me a lot about the human condition. And explained why credit card companies have troubles making money even with 20-30% interest rates: Some people just are no good. 
So instead of feeling "good" about throwing money away at people I feel like I understand people a lot better. Which is nowhere near as touchy-feely, but is one of those lessons they just don't teach in school…
This shouldn't be rocket science which is how bankers are paid, as if they are. This is a great idea and where we should be going. Einstein once said the most powerful force in the universe is compound daily interest. This should be expanded to 401ks where people could and probably should be investing in themselves not the stockmarket. What I mean is their mortgages, their car loans, school loands etc… The system now is to make unskilled workers (bankers) rich as if the invented APR and deserve patents for the rest of there lives. Gee what would competition do. people lending to other people and themselves included. Wow stock prices would be lower which is where you want to by them and dividends would be higher. I hope this trend continues and somebody honest in congress sees that this is also the way to go.
Looks like this is mainstream. I had a friend in college whose well-off family had their own lending club tradition. When a family member graduated college, the grandfather bought them their first home in cash, and they paid him back over 10 years at 0% interest. Hitting mid-career at 32 years with their first home paid-off, has been very beneficial for these friends…kind of keeps the wealth in the family instead of letting the banks have it.
I have borrowed money from lendingclub, I have good credit, and I borrowed at 9% interest to pay off 15% interest credit card. I wasn't desperate to borrow, but I feel real good about giving the money to individuals rather than the big banks who are ruining the country
The fact is that America needs new ways to manage their money and gain credit. P2P lending sites like Prosper are creating new ways for that to happen.