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What is Prosper and how does it work? Prosper.com is a website for personal loans that allows borrowers and lenders to find each other in an Ebay style auction. I've been a member of Prosper for over a year. In this article I'll tell you how Prosper works.

In a previous article about person to person (p2p) lending, I wrote about how person to person lending works in general. I also gave a brief description of the most popular p2p lending sites.

As promised this is the detailed article about prosper.com. While researching the article I came across another article about prosper on our sister site healthyreader.com. It's a pretty good introductory article so I'd recommend reading it.

How Does it Work?

If you want to join Prosper, you simply sign up and fund your account. However, don't expect to start bidding on loans right away. Fund transfers now take about 3 days to complete. This is one of the major complaints I've heard from Prosper users. We want instant gratification and a 3 day wait doesn't exactly qualify as instant.

Prosper has taken steps to decrease the wait time. Certain qualified lenders can get instant transfers. The transfer amount must be between $500 and $10,000. The sum of the pending transfers must be less than 20% of your total active loan amount. So this is a feature clearly aimed at power lenders.

Once your transfer has gone through, you can start bidding on loans. Borrowers submit a short description of the purpose of the loan. You'll find the usual reasons: consolidate debt, medical bills, home remodeling, vehicles, weddings, etc. You'll also find something quite unusual. A large number of loans are to reinvest in prosper itself. This deserves some explanation.

Loan Arbitrage

Some people borrow money on prosper to loan it to other people on prosper. At first this sounds like a rather odd thing to do, but it's actually quite common in the financial world. It's called arbitrage. Arbitrage involves taking advantage of some type of price disparity (difference) in the market. For example: gold is trading in China at $1000/ounce but it's trading in the US as $1250 an ounce. Obviously if you could buy in China and sell in the US you could make money. This is probably an oversimplified explanation but it will work for our purposes.

On the Prosper site, people with good credit (a valuable asset) can get a loan at a relatively low interest rate. These people then turn around and lend the money to more risky borrowers at a higher rate. The difference between the rate they borrow at and the rate that they lend at is their return (profit). However they are also taking on the risk of these less credit worthy loans.

As you can imagine this can be quite risky. I'll write more about arbitrage in my next article.

The Auction

Borrowers list the purpose for the loan and a maximum rate they are willing to pay. They submit to a credit bureau check. This information then becomes available to lenders. Prosper has powerful search feature that let you search based on almost any criteria. You can filter by credit grade, amount, Debt Ratio (Debt to Income), rate, purpose and almost any other field. You can also save your searches for future use.

A quick comment: a credit grade is not a FICO score. Unfortunately, you don't get a credit score on the borrowers, instead you get a credit grade. The credit grades go from AA at the top to HR (High Risk) at the bottom.

You can ask a borrower a question. For instance you can ask them to clarify or explain anything in their credit bureau, such as why they are behind in payments. The borrower then has a chance to respond. The questions can either be private or public. The public questions are listed on the loan for other lenders to see.

Once, you've found a loan you'd like to bid on, you enter the amount you'd like to bid and the minimum rate you'll accept. The lowest amount you can fund is $50. The rate has to be equal or below their current rate. A lender doesn't have to fund the whole loan. In fact most of the time a lender will only fund a small part of the loan. This reduces the risk a lender faces if the borrower defaults on the loan.

The bidding process warrants further explanation. If the loan is fully funded, meaning enough lenders have bid on it and the sum of the bids is greater than or equal to the amount the borrower requested, you call still bid. If you bid however, you'll have to accept a lower rate than what the current winnding lenders have accepted.

If a loan of $10,000 is fully funded at 10% interest you would need to accept 9.5% or less to have a winning bid on the loan. The most desirable borrowers, those with strong credit, have their rates bid down in the auction process. Therefore even if they start with a higher rate, they may end with a much lower one if they have good credit. This is what attracts borrowers to the Prosper site. They have a chance at a lower rate than they can get at a bank.

Each loan is available for bidding for a fixed period of time. Once the time expires the borrower can still reject the loan or accept the terms. If the borrower accepts they get the money and the following month the lender will (hopefully) start receiving payments.

Improvements

Prosper has seen many improvements since I've been a member. They've improved the user interface. They've improved the lender experience. Lenders have additional tools to evaluate borrowers. There is also a new instant transfer feature available. This addresses one of the primary complaints many users have; the length of time it takes to transfer funds to prosper.

Portfolio Plans - Loan "Mutual Funds"

There is a portfolio option available to lenders. You can set up some basic criteria for loans and Prosper will automatically bid on the loans for you. There are five options. The first four are simple: conservative, balanced, moderate and aggressive. These options are somewhat like a mutual fund where they give you an estimated return and an estimated risk. Of course your mileage may vary. Right now the plans estimated returns are 7.01%, 8.00%, 8.56% and 10.21%, from most conservative to most aggressive. You have a fifth option where you can setup your own criteria.

In theory the person to person process works fairly well. But how does it work in reality? Do borrowers repay their loans? Is there a higher delinquency rate because these loans are made online?

I'll answer these questions and more in my next article on Prosper.

Tags    Loans    Person to Person Loans    Prosper

Related Posts

• Moving My Money Away From Prosper
• Peer to Peer Lending with Prosper Et Al.
• Lending Money on Prosper: What Are the Risks?
• Lending Money on Prosper: My Results
• Prosper Increases Maximum Interest Rates

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