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Personal Lending Update

Contributed by mm | May 15, 2006 3:51 PM PST

It has been a little over two weeks since I started trying Prosper.com, a web community based lending platform. Have this two weeks turned me to a loan shark?

What I can say is it is a very interesting (and addictive) exercise. Here is my record so far:

• Funded 19 loans so far for a total of $1,562.
• Diversification is important to me so I keep my average amount per loan at $82.
• So far, all my borrowers have a credit score of 640 or higher. (In Prosper.com it means credit grade of C or above.) I have yet to explore loans with high risks.
• The interest rate on these loans ranges from 12% to 20% with a weighted average of 15.6%.
• On a risk adjusted basis, my weight average interest rate is 12.8%.

My goal is to expand my portfolio to 80-100 loans with an average loan size of $80 and a risk adjusted interest rate of 11%.

Of course it is too early to tell my performance since it will still be another two weeks before some of my borrowers will start making payment. However, it is not too difficult to figure out the rules of the game. In short, it is all about discipline and diversification.

Discipline:

To begin with, one will have to set up an expected return first. My expected return from this personal lending game is 11% adjusted for risk. Using the historic default rates by credit grade from Prosper, it is easy to figure out the nominal rate you will need to charge to account for the risk:

prosper.GIF

While every one can have a different return expectation, it is still beyond me why HR(high-risk)-graded borrowers can get loans at 10% nominal interest. Apparently many lenders underestimated the risk they signed up to.

Diversification:

While access to credit profile gives lenders something tangible to hold on, we are still talking about lending money to someone you don't know in your life. The way out is to participate in more loans but in less amounts, and take the historic default rate as the necessary cost of doing business. My practice is to lend only $50 by default ($50 is the minimal at Prosper), but only raise my wagers when borrowers give me convincing evidences they are good risks (thru spotless credit profile or reasonable purpose descriptions).

I'll keep you updated as I'm building out my portfolio. Keep tuned.

This Post Has Received 18 Comments. Share Your Opinions Too.


Matt Commented on May 15, 2006

Great post. I saw an article regarding this website a few months back and have been thinking about lending myself. I've been waiting a few months for them to work the kinks out and see if any lendors have any major issues. Based on everything I have read so far though, it seems to be working out.

http://thefidelityreport.blogspot.com


Early Riser Commented on May 16, 2006

Thanks for the post. I'm still waiting for my money to be deposited at Prosper so I can start lending. One note on your risk adjusted table above - did you include Prosper's 50 b.p. fee that is deducted from the lender's interest rate? If the rate is 11%, you will only receive 10.5%.


hs Commented on May 16, 2006

from prosper.com
When and how is my credit grade calculated?

When a borrower initiates the process of posting a loan listing on Prosper, we check to see if we already have a credit grade on file for that person and, if it is less than 30 days old, associate that grade with the listing. If we do not have a credit grade on file which is less than 30 days old, we initiate a query to Experian to retrieve a score and calculate the corresponding credit grade.

I think this is danger, because if some people can borrow lots of money within 30 days from sources loke prosper & default it all loans..

What do you think.


Apex Commented on May 17, 2006

What are the tax ramifications of this activity. Does prosper report 1099-INT income. Are you expected to report it yourself. How do defaulted loans affect tax basis? Seems like it could be a bit messy for such small amounts of return. How are you planning to handle it?


Ankit Commented on May 17, 2006

Early Riser, if you were to adjust for the 0.5% fee, here's what the return table would look like:

0.2% 0.9% 1.8% 3.3% 6.2% 10.4% 19.1%
8% 8.72% 9.49% 10.49% 12.20% 15.67% 21.09% 34.12%
9% 9.72% 10.49% 11.51% 13.24% 16.74% 22.21% 35.35%
10% 10.72% 11.50% 12.53% 14.27% 17.80% 23.33% 36.59%
11% 11.72% 12.51% 13.54% 15.31% 18.87% 24.44% 37.82%
12% 12.73% 13.52% 14.56% 16.34% 19.94% 25.56% 39.06%
13% 13.73% 14.53% 15.58% 17.37% 21.00% 26.67% 40.30%
14% 14.73% 15.54% 16.60% 18.41% 22.07% 27.79% 41.53%
15% 15.73% 16.55% 17.62% 19.44% 23.13% 28.91% 42.77%

The formula is this: ( (1 + Expected Return + 0.005 ) / (1 - Default Rate) ) - 1

The 0.005 is the Prosper's 50 b.p fee. Expected Return and Default Rate are to be entered as decimals, i.e., 0.2% = 0.002


CPA1298 Commented on May 17, 2006

Unfortunately, Prosper imposes a maximum rate of 23.75%, which eliminates a good-sized chunk of the southeast corner of that table.

It's ironic that Prosper is democratizing access to capital while at the same time imposing price caps.


Guest Commented on May 17, 2006

I love Prosper.com but I wish it existed 10 or 20 years ago. With the huge volume of increased fraud, identity theft and such I think it's probably only a matter of time before someone (or some group) scam the hell out of these people. Something similar happened in the past with paypal wannabe's except it involved credit cards but I don't quite recall the name of the dot com that went under because of it. I'll wait it out to see what shakes up over the next year.


Mark Commented on May 24, 2006

On the issue of taxes, this is from their FAQ:

Do I have to pay taxes on the money I make at Prosper?

Your income from loan interest is normally classified as taxable income. Every tax year that you earn more than $600 in interest, Prosper will send you a 1099 form summarizing your taxable interest income earnings.


Apex Commented on May 25, 2006

Thanks for the tax details.

Interesting that they only do it if your interest is over $600.00. Any interest over $10.00 is usually reported on a 1099.

Any idea how defaults are deducted?


Mark Commented on May 25, 2006

I think it has to do with the fact that Prosper isn't paying you interest themselves, but selling you a loan and collecting the interest on your behalf before passing it along. So they fall under the more generic $600 reporting requirement (the catch-all reporting requirement for basically any income-producing financial transaction), rather than the lower $10 for interest-bearing bank accounts.

As a side note, the IRS actually requires that you declare all sources of income in excess of $400, so there's an odd $200 gap between the self-declaring threshold and the other-party-reports threshold, in which if you omitted that income you'd be breaking the law but with a lower chance of being caught.

A defaulted loan could probably be treated as a capital loss, and offset capital gains from other investments but *not* other income from the loan (which is interest income, which can't be offset by capital losses). Formally, you're purchasing loans from prosper.com, and if one is defaulted, eventually it gets sold off to a bad-debt agency on your behalf for some small fraction of its initial value. So you suffer a capital loss of (loan value minus selloff price). This may be tricky to report, though, since a lot of this gets automatically done on your behalf by prosper.com.

(Note also that I'm not a tax expert.)


We're In Debt Commented on June 3, 2006

We we're playing around with the site earlier today, and I think that their credit grading system is slightly off. Our three major credit bureaus have the two of us very near the 700s, but Prosper only had us at a grade E (mid 500s). Something seems slightly off about that. does anyoen know if they use a separate scoring system?


personal finance Commented on June 10, 2006

prosper is an excellent tool for those who have high interest rates on their credit cards who can't switch cards to get a lower rate, but want to reduce their interest charges. There are certainly some possibilities with lending money, but you do need to make sure to diversify your lending since there are risks of non payments. I'll be interested to see what happens over the next year and whether they are able to avoid the con artists from spoiling their set up.


Jeni Commented on June 27, 2006

I actually just set up an account on Prosper as a borrower. I'm interested to see how this thing works as well. I've also noticed that my credit score is lower on Prosper than on other credit sites. My credit score is supposed to be in the mid 600s, but Prosper put me in group E (599 and below).

If you would like to take a look at my listing on Prosper, here's my Listing #21874



Coach Coin Commented on July 11, 2006

I recall reading that all loans are for 3-year terms. Is that still the case? Tough to consolidate larger debts (like school loans) in that time frame.


Credit Servicer Commented on July 15, 2006

Do you know if they simply look at the credit scores, or they look at the entire credit report?
Also what is the shortest term that you can lend for?

Interesting site. Please keep us posted.


Alex Ell Commented on July 24, 2006

Hi,

Great post, thanks.


Louise ONeal Commented on November 29, 2006

I was checking the website in october and came across Prosper.I am on my sixth try with no success.I had good credit but i made the mistake to loan to family and friends that didn't pay back
that made my credit bad.I lost $30,000.00 at one time because of a family member.I put in for this loan at prosper to get my credit back in order.
I am a christian lady that believe in doing the right thing My bills are current Family and friend got my credit bad .I am a very good risk because i am a stable person that tries to keep my word,anyone that help me i do not let them down
My listing at prosper is #66658 and my last i will not try again because i am a lady with pride i beg for a while but after i see that no one will invest in a good hearted person me i give up and put it in the Lord hand.So good luck to everyone and may God bless you all.


Debt Consolidation Union Commented on December 3, 2006

This is my first time to hear about propser.com. It seems like an interesting concept.


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