Prosper.com is a service that allows people to lend money – with interest – to other people, and thus turns everyone into a bank. I’ve put off writing this review for a while because I wanted to make sure this service was legitimate before endorsing it. It is, and I’ll explain why below.
Here is how the site works: Borrowers sign up with the site, then run their credit score through the site (Prosper currently uses Experian for this). Prosper converts the borrower’s credit score into a letter grade to simply things. For example, a 700 credit score would translate into a B rating on a scale with the following grades: AA-A-B-C-D-E-HR (HR = high risk).
The borrower then tells Prosper how much they’d like to borrow and Prosper gives the borrow a feel for what they can expect to pay interest-wise on their loan. A borrower with a B rating who’s looking for $1000-5000 is currently able to borrow money at 13.95%.
Next step: The borrower then starts a week-long auction for their loan. Sticking with the B rating borrower example, the borrower would probably want to start their auction at a higher rate – say, 18%. Once that goes live, people on the lending side of Prosper (including me) will bid on the borrower’s loan in increments of $50 up to the full value of the loan. Before long, a group of dozens (if not hundreds) of lenders will, together, fulfill the loan. But there will still be plenty of time on the clock. At that point, lenders will start outbidding each other and start driving down the rate of the loan do something below 18% and probably in the 14% range based on historical patterns.
When the week is up, the borrow has the option on whether to take the lender’s offer or skip it.
If accepted, the lender’s money is transfered to the borrower, who repays the loan in fixed payments over three years (36 monthly payments).
I’ve only used the service on the lending side, and I can tell you that it works very well. In fact, it works better than expected, but I imagine that’s because it’s still early and an imperfect market. I believe the balance of borrowers to lenders favors lenders right now, so lenders are getting surprisingly high returns on the money they lend.
My current rate of return on money I’ve lent is 13.59%. Yes, that’s correct. And none of the borrowers I’ve lent money to haven’t fallen even one day behind on their payments.
My Lending Strategy
When I first started using the site, I reviewed borrower’s stories and checked out their reasons for borrowing money. I would then bid on the cases that seemed like a fair risk. However, I was often bumped out by other lenders who came later to the same auction which led to more time than I wanted to invest. So I switched over to using Prosper’s portfolio management plan. With this, I simply tell Prosper what my risk tolerance is, and they’ll auto-bid on loans in dollar increments that I set.
This is also nice because Prosper will auto-fulfill loans whenever my account accrues $50 in repayments from other borrowers. Get that money back to work, pronto.
I’ve talked about this with a lot of friends, and here are the common questions I am asked.
Is this secured debt? No. There is nothing to repossess if the borrower doesn’t pay. However, lenders are required to choose a collections agency to work with on their behalf, assuming a borrower falls behind. Prosper has a separate market to help you determine which collections agency has had the best results collecting on overdue debt payments. There is a small fee for this.
How can I tell whether a borrower is legitimate? Proper publishes a ton of data about a person’s financial history after running the borrower’s credit score. This will give you a feel for how much debt they already have, how much they make, etc. You can also ask borrowers questions (and read questions and answers from other prospective lenders). Over time, the site also keeps a history of borrowers so people can build credibility up within the site similar to Ebay’s rating system.
Who started Prosper? The folks who founded e-Loan, so they have serious experience with online lending.
How do I get started?
I am definitely NOT a financial adviser, but if you want to give it a try, here is what I recommend: Sign up with the site as a lender. Go through the verification process, then fund your account with $75. Once the money hits your Prosper account, lend someone $50 to get a feel for how the system works. Once you’ve successfully done that, Prosper will give you a new-lender $25 bonus. Then lend out the remaining $50 in your account. You’re up 33% at that point and have a much better feel for whether this is something worth pursuing.