Essay on People to People Lending

This is an essay I wrote on People to People lending. I specifically looked at Prosper.com with my given examples.

At times in their life, people need money for a variety of different reasons. When they need money to buy a car, pay for medical expenses or raise some capital for a new business venture, usually money is sought after in a form of a loan. When a person needs a loan, they think of going to a bank, not their next door neighbor. With the rise of the internet, their thinking may change. New websites have been developed providing a new and growing alternative to loans from banks, which are called person to person lending web sites. “These sites, with names like Prosper.com, Zopa, Lending Club, and GlobeFunder, use social networking tools and other software to simplify the borrowing and lending of capital between strangers and even family and friends.” People to people lending is a great way to invest because it is easy to understand, it helps both the borrower and the lender financially, and despite the risks, it can have a high return of investment. Though there are several companies that provide people to people markets, emphasis will be placed on America’s largest one, Prosper.com.

“People to people” (P2P) lending “has been around since the days when needy families turned to the richest man in town [to borrow money], but now the Web is breathing new life into the practice”. A difference now is instead of just getting the whole lump sum of money from one person, borrowers are funded through many different lenders adding up to the sum total requested. The P2P markets help bring these borrowers and investors together.

Borrowers seeking loans will register with the website and submit information to verify their identity. They will create a listing for the loan they need, with the amount needed and information about themselves. Usually they will describe what they plan to use the money for and show how they plan to pay back the loan. Through Prosper.com, all loans are for a period of three years, though borrowers can pay it off earlier without penalty. The loan listing can be up to $25,000 and the borrower will set the maximum rate they are willing to pay for the duration of the loan.

Prosper.com has also been described as “the eBay of loans” because of the similar bidding process used by itself and eBay.com. Lenders registered on Prosper.com can “bid” on an assortment of different listings created by borrowers. These lenders can then set the minimum interest rate that they are willing to earn and the amount they are willing to invest into each loan, as little as $50. Lenders can look at credit scores and histories on their potential borrowers, as well as read the borrowers personal stories and endorsements from friends. When the auction ends, Prosper takes the bids with the lowest rates and combine them into one simple loan to the borrower. Prosper takes care of all on-going loan administration tasks including loan collection and repayment on behalf of the matched borrowers and lenders.

Many people know the value of investing their money; they just don’t have the knowledge or information how to do it. Some may feel they do not have a large amount money to invest to really put forth all the time and effort into researching stocks and bonds. Others just don’t know where to start. Prosper.com has made the process to start investing very easy. All someone has to do is register through the website, providing some information so they can verify their identity. Then they can transfer money from their checking account and start bidding on loans. There are no fees to register and also no annual costs. Investments can be made with as little as $50.

Once money is transferred, it is simple to start investing. Lenders can set up parameters on the search to only show certain types of loans. Some lenders like to browse through the listings to find someone that they believe in. This was something noticed by the Associated Press in their MSNBC article. “Prosper’s added appeal, however goes beyond the bottom line. Photos and personal narratives accompany borrowers’ requests: A father who needs $25,000 to equip a house and car for his son, who has recently begun using a wheelchair. A young couple seeking $5,000 for their wedding, who plead, ‘Please help us get married’”. Prosper’s CEO stated, “Borrowers can appeal to lenders to look past a couple of late payments or spotty credit history, while lenders enjoy the satisfaction of seeing their money help someone in need." Seasoned investor, Michael Fisher, was quoted saying, “It’s just more fun to invest in Prosper, than to, say, invest in stocks. You’re closer to real people." Helping out others financially, while helping yourself earn a profit is a double plus for P2P lending.

Like other investments, P2P lending does have some risk. P2P loans are similar to personal loans from a bank, which are unsecured loans, which means there isn’t any collateral backing the loan. There is no guarantee that investors will get their money back. If a borrower defaults on their payments, which means if they are late on payments over three months, then Prosper lenders can choose from three different collection agencies to pursue the delinquent borrowers. These collection agencies have only had limited success so far. Defaulted borrowers don’t get away scot-free though; their late payments are reported to all three credit bureaus and their credit scores will take a hit. Still, warnings abound with the risk of these types of investments. Christopher Steiner from Forbes magazine states, “Let’s not forget, however, that serving as an unsecured lender is a risky business. While bad loans are minor now, just wait until an economic downturn comes around." As read from an Associated Press article, they took note of the risk involved. “Prosper’s default rate hovers at about 2.7%, but that figure is expected to rise as more loans mature." As predicted, the number of defaults has risen an additional 2.2% as seen on Lendingstats.com bringing to total to 4.9%

Jane Kim from the Wall Street Journal remarks on some of Prosper’s efforts to calm some of the investor’s concerns. “Prosper requires that borrowers have a minimum credit scores of 520 and promises to buy back any loans that are the result of identity thief.” She also suggests to “diversify by making small loans across a variety of borrowers” and to loan to those with “clean credit histories." Steiner quoted an investor, Craig McHugh, who gave another reason why there may be a lower risk. He said, “Because these people are borrowing from individuals who chose to help them out rather than Big Brother, they’ll feel more obligated to pay back the loans." Steiner also states that the average default rate for credit card companies is around 4.4% which is very close to where P2P’s default rate is at. He shows that there is risk in every investment.

The P2P market is a growing alternative to traditional sources of investments, such as the stock market, money markets, and certificates of deposit. Each type of investment has its own positives and negatives associated with it. Money markets and certificates of deposit are extremely safe, both being insured by the Federal Deposit Insurance Corporation (FDIC) up to
$100,000. Stocks and mutual funds have a higher degree of risk, because they rise and fall with the market and economy. These investments, however, have a higher return compared to CD’s and money markets. P2P lending, as stated before, are unsecured loans, similar to stocks which also lack security. These P2P investments could be lost if the borrower goes bankrupt similar to how stock values would plummet if the company went bankrupt. It should be noted however, that investments on P2P markets are independent of rises and falls in the stock market, which would make it great to diversify an investor’s portfolio.

Comparing the different return of investments, Zion’s Bank’s website listed its Internet Money Market to be at 2.89% annual percentage yield (APY), while Mountain America Credit Union had a twelve month certificate of deposit at 4% APY. Over the last year the stock market has been up and down, but through the last three years there has been a climb. MSN’s Money website shows that the S&P has been up 12%, the NASDAQ up 14.6% and the Dow up 17% over the last three years. That would come out to be about 4%, 4.9% and 5.7% per year respectively. Rates supplied from Prosper.com shows that the average rate of return for lenders on higher-grade loans (credit scores above 720) is 8.64% and loans with a lower-grade (credit scores between 560-719) is 6.9%.

From this data, it is seen that there is a good return on investment with investing in people to people lending despite the risks involved. Investor Andrew Balto, spoke to the Wall Street Journal about how he pulled out some of his investment money from certificates of deposits and money markets accounts and the money into over 350 different Prosper loans. He uses Prosper as only part of his total investment portfolio. In all investments, having a diverse portfolio is best and safest when shaky times come. Using P2P lending as an investment avenue is a wise decision.

As discussed, people to people lending is an excellent way to invest because of its ease to learn, the satisfaction gained from helping others and its high return of investment. Though people to people lending will never replace the stock market or other safe investments such as CD’s or money market accounts, it has provided another great way to invest your money.