Peer to Peer Lending Comes of Age
Over the past year and a half I have been experimenting as a lender on several peer to peer lending websites. The idea is simple. Rather than have a bank lend money to an individual, a group of people lend the money instead. Lenders bid on a slice of the loan at whatever minimum rate they are willing to offer. After enough lenders have bid, the loan becomes fully financed and additional bids start knocking the loan's interest rate down. (think eBay) If your lending rate as a loaner is less than or equal to the current rate, your bid stands. When bidding finishes, a disbursement is made to the borrower and they begin to pay back the loan. Lenders get to spread the risk across a number of loans while borrowers benefit from lower rates as lenders compete.
I think the explosion of peer to peer lending like this comes from the confluence of several factors: the many to many nature of the Internet, people's willingness to make financial transactions online and the credit squeeze as traditional capital markets tighten up. Of course this kind of investing still bares "head for the hills" signs. Peer to peer loans are usually not insured and are generally uncollateralized to boot! But if you can stomach the risk, peer to peer lending can be significantly rewarding for lenders in the game for the long haul.
I started out with Kiva which offers a philanthropic wrinkle to the peer to peer lending idea. Kiva streamlines micro-loans to entrepreneurs in second and third world nations, a cause near to my heart. The loans are interest free for the borrower under the idea that giving someone a fishing pole and teaching them to fish is more sustainable than just donating fish. As a lender, you typically bid on a slice of a loan totaling less $1,000 for something as simple as a peanut grinder or a sewing machine. The local community elects and vouches for the borrower in hopes that they too someday might get a loan. If the loan is paid back in full, the local community gets to elect another member for a loan. It is literally stunning to see how much of an impact a few hundred dollars can make in a developing community over time. Last Christmas I gave out Kiva gift certificates as presents.
Eventually I began to investigate the for-profit peer to peer lending market as well which includes Prosper.com among others. As these for-profit peer to peer loans carry interest rates anywhere from the low single digits to upwards of 35%, there is ample opportunity to significantly out-pace the return you would get from your average bank. If you think about it, a traditional consumer bank thrives on the spread between the interest they pay on the financial instruments they offer such as CDs (let's say 3%) and the loans they make to people and small businesses on things like credit cards. (lets say 14%) That leaves 11% to cover operational costs, marketing, risk and profit. A peer to peer lending company such as Prosper.com can run with a significantly lower overhead (typically charging about 1%) letting you as a lender enjoy a much more significant portion of the spread. It brings economies of scale to the traditional banking model with the added benefit of distributing risk amongst many borrowers rather than one bank.
However, as mentioned before, it isn't all roses. For an idea of how Prosper.com has been working out for me, I decided to post some real-world numbers. Now one could easily make the claim that I am fairly risk tolerant at this point (I'm still fairly young) so don't think of this as your average portfolio. Also keep in mind that these are results from ~1.5 years of usage, hardly a statistically relevant sample.
Of 281 loans, only 250 are current. The number of loans that are less than 15 days past due fluctuates quite a bit. It is usually at the top of the single digits in my case but maybe the broader economic trends are catching up to me here! If a loan reaches the 2 months late bucket, especially with the first payment, I probably won't see that money again. You do sign up with a collections agency when you start up so some of that money might be recovered though you can't count on it. The good thing for me is the average interest rate in my case is somewhere in the neighborhood of 28% across all of my loans. It remains to be seen how the numbers will pan out though. I'll do a post in another two years when a significant number of loans have come due.
So what has your experience been with peer to peer lending? Anyone else care to divulge some numbers for comparison? Do you see peer to peer lending as a fad or is the market really moving in that direction? What other peer to peer lending banks have you tried? Leave a comment!
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