My Personal Finance Journey

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Is Micro Personal Lending Worth the Trouble?

Contributed by mm | July 24, 2006 9:49 AM PST

I recently mentioned that I have been addicted to Prosper, the online marketplace that allows people-to-people micro lending. On average, I am spending 15 minutes a day on the site finding credible loan requests I want to get involved. However, is it worth the trouble -- both the time and (slightly) loss of sleep during the night -- to make some handsome returns?

Maybe the best exercise is to apply a quick mathematical model to calculate the return on my invested time. First, let's start off by assumptions:

• Based on my track record, I am underwriting micro personal loans at $80 apiece.
• The weighted average nominal rate I charged is 18%. Factoring in the Prosper fees, and some (unavoidable) charge-offs, I expect to get a return rate of 12% -- this is to assume that 1 in 20 of the loans in my portfolio will end up in collection.
• On average, I can close a loan every day, or every 15 minutes of time spent on Prosper site.
• The risk-free market rate for highly liquid money market account is at least 5% (like in the case of EmigrantDirect). If we forget about the inverted yield curve for a moment and assign some risk premium for the 3-year term nature of all Prosper loans, I would assign a comparable risk-free market rate of 6.5%, which becomes opportunity cost of underwriting more unsecured personal loans.

Here comes the calculation:

• For a typical 3-year Prosper loan of $80 and 12% interest rate held till maturity, I should be able to collect $15.66 in interest over the lifecycle of the loan.
• If I commit $80 to a risk-free vehicle at 6.5%, and gradually take out principals as the amortization schedule of the Prosper loan dictates (for an apple-to-apple comparison), I should be able to collect $8.48 in interest.
• That's a $7.18 difference per $80 loan. If we normalize the different cash flow patterns by an interest rate of 8%, the gap between the two alternatives becomes $6.59 in Net Present Value (NPV).
• In other words, for every 15 minutes I devote to personal lending, I can expect $6.59 in return, which means I earn a bit over $26 per hour by my time at Prosper.

This is really a lot of sweat!

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This Post Has Received 2 Comments. Share Your Opinions Too.


Jonathan Commented on July 25, 2006

I like your in-depth analysis, especially that you take into account that these are 3-year loans, and that you have to amortize your interest gained. Too many people simply compare the interest rates to banks.

What I'd like to see is some analysis of the returns and default rate as compared to a BBB-rated bond or the like.


Coach Coin Commented on July 25, 2006

MM - are we to assume you are doing this on your personal time or during lunch and/or work? Not that I'm suggesting you'd double-dip but I have been known to run contracting gigs during downtime at work and thus being paid twice for each hour. Just curious. ;-)



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