This is the 4th post in a series of articles about Prosper.com. Prosper is a person to person lending site with an auction format similar to EBay. I’ve been lending money on Prosper for awhile. In this article I’ll write about my results.
I Wanted Higher Returns
When I first discovered prosper, I was looking around for higher returns on my investments. I had a lot of money sitting in savings accounts at the time. I wasn’t happy with the rate these savings accounts were paying. I even had high rate online saving accounts with ING and HSBC but the higher rates on these accounts didn’t last very long.
I Wanted to Diversify
I felt at the time that I had enough in cash, real estate and the stock market. I wanted to diversify my assets. Personal loans seemed like a good way to do that.
I started with Prosper back in January of 2007. I placed bids on 2 loans. The first loan had a A credit grade and the second had a AA credit rating. I funded the minimum of $50 on each loan. As you can see I was very conservative at first.
Everything went fine, the borrowers got their money and they started making their payments. I waited until May to bid on more loans.
I made two more loans in May, another A and AA. I made another loan in June. The loan in June was unique. It was and still is my only B loan.
In October I made 3 more loans, all A grade. In December and January I made one A grade loan each month. I now have a grand total of 10 loans.
I Wanted to Make More Loans
Right now I have cash sitting in my Prosper account. I wanted to make more loans but I soon discovered two things. First, it’s very hard to find AA and A grade loans which offer a decent return. Secondly, I’m very risk adverse.
I have a saved search that I use to find loans. I only want AA, A or B credit grades that pay 10%, 11% and 12% respectively. I want a debt to income ratio less than 35% (that’s what most lenders typically use). I wanted 0 delinquent accounts. First credit line had to be 5 to 10 years ago to try to eliminate bankruptcies that had just fallen off the credit bureau. People with bankruptcies have very short credit for their age. For instance, a 50 year old man with 5 years of credit is very suspicious. I wanted only full time or retired, no self employed or students.
You can see that my criteria would give me only the best borrowers at a rate that would still allow me to make a profit. The problem is these borrowers were very hard to find.
Most of the loans that matched these criteria were fully funded, so you ended up bidding down the rate and getting less of a return. The others had some bad situations like medicals bills.
Don’t ever get involved in a situation with medical bills! I can’t emphasize that strongly enough. You don’t have enough information as a lender to asses the situation. Is it from a child birth or is it terminal cancer? You just can’t know, so stay out.
Too Much Work
After awhile I felt searching for loans became too much work. I wanted to select the loans as I don’t trust the automatic options. I want to analyze each borrower's situation. My experience in the credit department came in handy as I knew what warning signs to look for, things like medical bills, too short credit for age, self employed, etc.
I found myself having to constantly log in and run a search to find maybe one or two worth bidding on. If I did get lucky and find a good borrower, many times I would be out bid.
Beating the Stock Market
My goal when I started with Prosper was to get a rate of return that matched the stock market. If you figure 10% (which is a little aggressive in my opinion) as the average market return then my loans had to beat that.
I was not going to accept low rate loans, so my search for a good loan was long and arduous. Something happened in the meantime that made me realize I was underestimating my risk.
Losing All Your Money
I realized you could lose all your money. At the end of last year one of my borrowers just stopped paying. This guy had a AA grade rating. Right now he’s 4+ months late. There are only 25 AA’s out of 15,429 loans that are 4+months.
I had been reading Grahams’ Intelligent Investor at about that time and his advice really hit home. Graham emphasizes protecting your capital (money) above all else. I had known that someone could default but by looking at the loan performance page, it seemed very unlikely, especially considering this was a AA grade borrower.
I invest in mutual funds. If the market is down, I end up with more shares. If the market is up I end up with fewer more expensive shares. But there’s very little chance my shares would ever be worth nothing.
That’s not the case with loans. Banks budget a certain bad debt expense. Banks realize that a certain percentage of borrowers are not going to repay their loans for one reason or another. That’s part of the cost of doing business.
If you’re a small lender on Prosper, bad debt can eat up your profits and then some. Right now I’m looking at a $42.95 loss. In the big picture, it’s not very much money. However, if 10% of my portfolio is going bad, that’s not a good thing. I knew that I could lose money, but until it happened, it hadn't registered in my mind.
I’ve made $29.91 as of today. With a $42.95 loss, I’m now down $13.04 and I don’t own any assets. At least with a house or a mutual fund, I can wait out a down market. Banks can sell their loans to other banks. With a bad Prosper loan, the only thing I have is a tax write off. I didn't have a tax write off in mind when I started lending.
Right now, I’m not that excited about Prosper. I did a lot of work to end up with a loss. There is no way to sell your loans, you have to wait 3 years (or until the borrower pays of the loan) to get your money back.
I think Prosper is great for speculators. If you love taking risks, I think you can do alright with Prosper. At this point in time, I’m spending more time than its worth.
I’m going to transfer my excess cash from Prosper into my checking account each month. I’m going to let my current loans pay off (hopefully). I will revisit Prosper again in 6 months and see if anything has changed.
If you have experience with Prosper, I’d love to hear from you. Are you doing well? Do you have a winning strategy? Leave a comment below and let me know what you think.