The idea of lending people money online is a fairly new one and the possibilities are intriguing. A peer-to-peer lending site launched about a year ago Prosper.com (founded by the VP of Paypal) allows people to lend and borrow money online from each other. Prosper has become a huge hit with over $100,000,000 in loans and over 50,000 members in it’s first year of operation. Its unique business model allows you to limit risk by making many small bids of $50 or more on multiple loans. So instead of lending a $1000 to one person you are lending it to 20 people and if one or two happen to default you are still making money. You can pick who you loan to based on information including their credit rating, verified income, debt to income ratio and more. 

Each Prosper borrower is assigned a grade based on their credit score to help lenders evaluate their risk and the site verifies borrowers’ identities and income. Prosper makes it’s money by charging a 1% or 2% closing fee, based on borrower’s credit grade, and lenders pay an annual loan servicing fee of .05%. Prosper also collects fees for late payments on behalf of lenders and reports to credit bureaus. After 30 days, a collection agency is assigned to delinquent loans.

MSNBC recently did a piece on Prosper and included was how much the lenders make.

Prosper allows you to become the bank thereby diversifying your investments from riskier stock market portfolios. The average Prosper rate of return is about 9.4% which is way higher then returns on a bank CD. Prosper is a great place to lend money to others and make a great interest rate for doing so.

Is 9.4% an acceptable return?
It depends on a full consideration of the risk vs. return of the investment. High prime consumer credit loans have a fairly low risk; with a historical default rate for Prosper loans at 2% for AA and A loans and 4% for B loans. When compared with the stock market, which for the last 80 years has delivered an average pre-tax return of 8% with a much higher level of risk, Prosper loans look more attractive. 9.4% also provides a healthy risk premium over risk-free t-bills or CD’s or Money Market Funds which are currently yielding about 4.5%.

I have recently opened a Prosper.com account and have invested a $1000 as a initial trial amount.  I am mostly lending to the higher prime tier (credit ratings AA, A and B) since they have very small default rates. I’m happy with it so far, but you do have to screen loans carefully. I will be increasing my investment in Prosper loans each month, reinvesting my loan income and sharing my loan investment results with you. You can veiw my loan portfolio and it’s performance here

Diversification

One thing that Prosper loans can do for our passive income portfolio is offer some diversity (with risk, yes, but with very little, if any, correlation to the market). It could help soften the blow during downturns in the market, ala bonds, real estate etc…

Minimizing risk

As with any high yield investment, there are risks. Loan investments using Prosper.com are a series of mini-loans made directly to other individuals.  These loans are fully amortized 3 year loans.  Each loan has it’s own origination date, payment date, interest rate, and expected ROI.  While the loans are not individually as secure as the FDIC guaranteed CD, collectively the risk is very small if proper care is taken when selecting loans.

My advice to those planning to lend on Prosper: 

• You have to be able to afford at least 10 loans ($500)–preferably more than 20 ($1000)–in order to take the risk of investing on Prosper. Otherwise if/when you get a default, your whole return (and maybe even more) can be wiped out. You have to be able to afford to diversify your holdings.
• Only lend to people with a credit rating of AA-C.  Don’t even think of messing with D-HR until you have 12 month of consistent lending experience. 
• Diversify, Diversify, Diversify.  You have to be able to afford at least 10 loans ($500)–preferably more than 20 ($1000)–in order to take the risk of investing on Prosper. Otherwise if/when you get a default, your whole return (and maybe even more) can be wiped out. You have to be able to afford to diversify your holdings. Also, never put more than 2% of your expected portfolio size in a single loan.  If you plan on having a larger portfolio stick to $50 loans until 25% of your loans are 6 months old before increasing bid size.  Continue to invest in $50 increments until this milestone is reached.
• Taking the emotion out of it by the use of Standing Orders is a wise move.  Create an advanced search defining your extended credit requirements, tweak the search untill it is finding loans you like. Then turn it into astanding order and let it find the listings for you. 
• Use automatic transfers combined with standing orders to automate your prosper lending.  Investing in Prosper is fun, but it can also be time consuming. Until such time as interest is paid on account balances, keep your cash coming into Prosper balanced with the listings your standing orders are finding. 
• Overlap standing orders to create ladders.  Ladder on Rate, DTI, loan amount, and homeowner status.
• Don’t follow the heard. Don’t bid down 100% funded listings. Higher interest rates are better than lower interest rates. 
• Use the following link to start your inveting positive $25: Prosper Referral Link Worth $25 to New Lenders

Lending on Prosper is fun and easy. Follow the above suggestions and you can have a healthy and profitable portfolio.  If you would like to get started with a $25 start up bonus a click the link.

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