Peer-to-Peer Financing

A few months back I decided to invest a little money through Prosper.com. If you haven’t heard of this site, or a similar one out of the UK called Zopa, it’s set up so that a group of individuals pool their money together and loan out money to other individuals.

The people looking to borrow money are rated based on their credit score, delinquent accounts, inquiries and so forth, and the better these factors are the better interest rate they can obtain. The people looking to loan out the money can choose to bid on whomever they choose based on how much of a credit risk they think the borrower is and how high of an interest rate they can get. Generally speaking, the higher the credit risk the higher the interest rate.

One of the appealing parts of P2P investments is the fact that your risk is reduced because you spread out your loans to a number of different individuals. You only need to commit a minimum of $50 at Prosper to any one borrower. If you transfer $500 to your account, you can distribute that to 10 different borrowers, or you can simply put it all in towards one borrower.

I had a lot of fun looking through the list of borrowers and picking out the ones I thought would provide the best risk/reward ratio. I spent a bit of time on this and finally picked out about 9 borrowers, none worse than a C credit rating and most of them AA and A. I ended up with an average interest rate of 10.92%, not too bad for a relatively safe investment. I think many Prosper lenders are able to get even higher rates with a little more work and risk.

Ultimately, I decided not to invest even more money in Prosper for two reasons. The first, and primary, is that if even one of my borrowers defaults my entire investment is a wash. Propser has safeguards in place to collect on the defaulted loans, but I have little faith that they would prove effective. Secondly, there is some lag time between bidding on an loan and the actual funding, in addition to some other time my money is simply sitting in my Prosper account rather than an active loan. During that time, my money earns no interest since Prosper doesn’t pay interest on account balances. If they could just throw me 4.0% to hold my money in between loans, I’d feel a little better.

In the end I feel that sites like Prosper could provide a nice investment opportunity for individuals not to mention a nice place to find a loan for those looking for alternative lending options. These sites are still in their infancy and in time I’m sure they’ll work out the kinks and make this an even more attractive personal investment vehicle.