An Easy Way To Make A Buck Or Gambling? Loan Service.
Written: Jun 13 '07 (Updated Jul 04 '07)
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Haven’t you ever thought about bypassing all those middlemen and getting a car/house/condo directly? What about loan? Sounds a bit crazy, is it? That’s what Prosper is all about.
Why do we buy used cars from people we do not know and houses direct? IT IS CHEAPER! Right? We, Americans, love it cheap. Why don’t we take or give loans from/to other people and prefer to pay some bank to do that for us? Two things stop us: we do not want to have to deal with people who we may know and we are scared of default. Bank eliminates both problems by taking care of the bad talking to clients who are late and punishing those in default. Apparently this protection does not come for free: we get miniscule savings account rates and pay a lot more when we want to take a loan. In fact, even with good credit history you will end up paying twice the actual price of the house bought on 30year mortgage.
How Does Prosper Work?
Prosper works by connecting lenders and borrowers directly and charging 0.5% fee on all payments. For this fee Prosper verifies borrower’s identity and credit score to provide you with reliable information about potential dollar cow… or loss. This is the basic idea.
Borrower’s Perspective
My Story
When I was in college I defaulted a whole bunch of loans and credit cards. Why? I just did not feel like it mattered to me, as I will always be able to earn more in future. Thus I was somewhere is the low 500s range of FICO and could not get any loan when I needed. I really needed it and was confident that I will pay THIS ONE back, but someone always applied same logic: if he defaulted ones, why should I believe that he will not default it again?
Why Can’t You Ask For Loan At The Bank?
How nice would that be to just go to the bank and talk to person, explain how miserable I am, how desperately I need just $2000 to pay back my credit cards and loan at school? No one cared! Banking system is built with a universal metric that minimizes averaged risk of default and does not care to what are the individual conditions.
Now, You, Losers And College Students, Got A Second Chance!
Prosper.com gives you a chance to explain the story behind your situation. You can write about all the conditions that MADE you DEFAULT before and why do you think you will not DEFAULT again. And people do: they write a lot about unfortunate circumstances in their lives, death in the family, lawsuits, car accidents – everything, but their own stupidity! You bet! Who would give money to someone who is just stupid? I would not.
How To Scam $25,000
If you look carefully at the listings you will notice a trend: credit card debt consolidation, venture business ideas are getting funded best! So don’t be a fool – if you got in trouble and overspent in Las Vegas, you should just write that you want to start an online store or consolidate and you will scam $5-25,000. Why these two? Simple: these are the only ones actually increasing your net worth in the eyes of the lender. If you want to raise funds for you marriage or funeral, buy a car or adopt a pet, all of these will result in decrease of your funds and capability to pay back. Credit card consolidation and business, on the opposite, will increase your cash and you are more likely to pay back.
You Got $25,000, What Next?
Theoretically you can delay payments up to three months without much damage, but if you default – collection agency will come after you. Everything is quite serious. However, like many times before, you can settle for 60% and make 40% on $25,000. There is not much there to stop you, unfortunately.
Lender’s Perspective
What Are The Alternatives?
The selling point of Prosper is that you make more than you could on CD. So how good this deal actually is?
You can find current CD rates on http://www.bankrate.com/brm/rate/deposits_home.asp
1 year CD will give you 4.85% on average (with inflation rate somewhere between 2-3%), thus your actual gain is ~2-3% before taxes.
The highest 3y CD I found was 5.31% from GMAC Bank – just a bit better. These are all risk – free investments. If you are willing to accept risk, you can gain more, but you can lose more as well. Thus Janus Fund will give you 15-24% on your investment yearly, but this may be the same next year or may not be https://ww4.janus.com/Janus/Retail/AllFundsOverviewPerformance
Prosper’s Rates Math
Prosper’s rates can be found here: http://www.prosper.com/lend/rates.aspx Basically you can make anywhere from 8% to 29% depending on the amount and credit ranking of the borrower. You can actually beat Janus with loans to E and HR groups credit grade. These are the groups: AA 760+; A 720-759; B 680-719; C 640-679; D 600-639; E 560-599; HR 520-559. Basic rate for E group is above 25% on $1,000 - $2,000 loan. Subtract fees and commission and you will be a bit below Janus Growth Index. But keep in mind that these 25% are guaranteed (if borrower does not default).
Whom To Lend?
Default Rates Math
This is the major point of the game: you want to minimize your risks. Historic performance is presented here: http://www.prosper.com/lend/performance.aspx
If we believe this data (?) then we can conclude that Prosper funded $67 mln in loans and $3.7 mln have been paid in full so far. This is a young company and it takes three years to pay off the loan, so this is Ok. But what about defaults? $1.345 mln in defaults. This is 2% in terms of money and 3% in terms of number of loans given. BUT it is 36% of the number paid in full! Why is it important? Because some of the loans will be defaulted on the way and it is INAPPROPRIATE to calculate percentage from the total number of loans given!
In addition to that there is 5% chance of late payments on average. But let's look at category E defaults (this is the category above Janus by return). Their default rate is 4.5% of total number given in this category, but 113% of the total number paid in full! WOW! So the ACTUAL chance of getting your money thrown in a trash bin in somewhere in between 4.5% and 113%! Nice!
How To Choose Borrower?
Same logic as before applies here – try to pick someone who has low debt to income ratio, who is not a college student, who has a steady job, and someone asking for loan for the cause that will increase his ability to pay it back. That is: credit card or loan consolidations or business venture if you think it will work. All others will just decrease the worth and your chances of getting mugged increase dramatically.
Take Home Note:
Think twice before investing with Prosper. It is a great idea, but it may not be such a great idea for you if you do not do it right. Choose people based on rigid criteria and not on your feelings and diversificate. You can invest as little as $50 in each loan which will make your losses less painful on average. At the same time 5% default rate (MINIMUM!) with 25% profit is still a risky venture. You may be better off investing in stocks.
I recommend it to people who are willing to play the game and take the risks, those who can spare few hundreds a month on this and are smart enough not to get tricked.
UPDATE: Obviously I overexaggerated with percentages; 113% is compared to fully paid loans, thus it is a bit incorrect to compare. It is still valid however that the ACTUAL default rate will likely be higher as more people default loans they took before but have not yet paid off.
Please ask questions if you want any clarifications on my math or analysis.
Thank you!
Recommended:
Yes
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About the Author
Member: Alex
Location: Cambridge, MA, USA
Reviews written: 68
Trusted by: 16 members
About Me: I enjoy writing essays on various topics, especially if it helps people.
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