• Invest $1,000 - $4,999 by December 31 and receive a 1% cash rebate into your Prosper account by January 22, 2010.
• If you invest $5000 or more, you will receive a 2% cash rebate into your Prosper account by January 22, 2010.

Taking advantage of the maximum rebate would net you a cool $100 and when compared with the current interest rates on savings accounts and CD's, it's definitely worth a look. To get more details about investing in notes at Prosper, click here.

Plenty of good money links out there this week.   Let's take a look.

• How Much to Budget for Car Maintenance @ Five Cent Nickel: Costly car repairs can throw a wrench into your finances, so it's best to so set money aside for the worst.
• October 2009 Unemployment Rate 10.20% - Chart of the Day @ The Sun's Financial Diary: Even though the recession appears to be over, the unemployment rate is going to get worse before it gets better.
• How to Earn Income for the Rest of Your Life: The Good, Bad and Ugly of Annuities @ GenX Finance: Even though that lump sum payment looks good now, getting it spread out may be the best course of action.
• Base Salary Isn't Everything @ Suburban Dollar: Don't forget that there are dozens of other ways to profit from a good job!
• Financial Literacy in Schools @ Financial Highway: Educating students about the financial responsibilities they will have in the future is key to making sure we don't get recession happy.
• Borrowing From Family and Friends - Bad Idea, Right? @ Debt Kid: Never have and hope I never have to. Probably best to consider the money gone the second you lend it out.
• What is Your Definition of Success? (A Tougher Question Than You Think) @ Wealth Pilgrim: Most people would equate money with success but there's a ton of other things that are also at the top of the list.
• Working Long Hours - Is It Worth It? @ Darwins Finance: Having a few recent jobs that I was regularly working 70+ hours a week, my vote is that long hours suck.  Definitely not worth it.

LendingMatch is an easy to use tool that enables investors to quickly create a portfolio of notes to invest in that match the investor's tolerance for risk. To show you how it works, I've created the video below showing how I used LendingMatch to quickly invest in some LendingClub notes earlier this month.

And if you are interested in becoming a LendingClub investor, check out the link below the video. Here's the video:

If you'd like to become a LendingClub investor, you can sign up at www.lendingclub.com.

The calculator is still in beta version, so please let us know if you encounter any problems. You can check out the calculator by clicking here.

As always, this past week saw a number of great blog posts and carnivals about personal finance. Here are few we found particularly useful:

Articles

• Got personal finance questions? Get answers at Moolanomy Answers. Pinyo has put together a first rate Q & A section to his site, and it's definitely worth a visit.
• Car Maintenance Tips: Help Your Odometer Reach 300,000 Miles (@Frugal Dad)
• Protect Your House While You’re on Vacation (@Being Frugal)
• Free and paid options for opting out of junk mail (@Bargain Babe)
• The sweepstakes ends June 30, so check out this opportunity to win $2,000 from Exxon and Citi.

Carnivals

• Carnival of Debt Reduction - “Four Pillars” Edition (@Four Pillars)
• Money Hacks Carnival #70 (@Blogging Banks)
• Festival Of Frugality- Honeymoon Destination Edition (@Financial Highway)
• Carnival of Personal Finance #210 – Punch Out Edition (@Suburban Dollar)
• Economy and your Finances Carnival- June 21, 2009 | OneMint (@One Mint)
• Carnival of Financial Planning #94 (@Canadian Personal Finance Blog)

Lending Club has figured out exactly what information users need, had has made that information easily accessible on its site. But back to the new tool, here's what it looks like in my account:

So in my case, net annualized return is about 5% above average. While that's great, even one default and the return would come down significantly. So far I've been fortunate. But it is remarkable that the average return across all Lending Club investors is 9.94%.

This past week I had the opportunity to discuss my Lending Club experience with Barbara Bryn Klare, a journalist who writes two columns for the examiner.com. Here article, P2P Followup: Growing up is hard to do is a good read. Barbara also mentions my good friend Pinyo, who is a Lending Club investor and runs a wonderful personal finance blog.

If you'd like to become an investor in Lending Club notes, you can do so at www.lendingclub.com.

And if you are wondering how LC calculates net annualized return, the formula is really, really simple:

Hmm, well maybe not so simple. Let's forget about that, and take a look at some great articles and blog carnivals that were published this past week.

Personal Finance Articles

• Top 50 Frugality Blogs that Will Help You Save Money (@Frugal Dad)
• Readers Share Lending Club Returns (@My Dollar Plan)
• The MOST important Making Money 101 tool of them all … (@7 Million 7 Years)
• The Big Bing Theory (@One Mint)
• 30 Things I Do Daily To Spend Less Money (@Domestic Cents)
• Saving $71,000 on Your Mortgage (@Bad Money Adcvice)
• Don't let low interest rates make you stupid (@Wise Bread)
• Make Your Own Dog Food (@Bargaineering)
• How Much is Your Time Worth? (@Cash Money Life)
• Joining An Investment Club? Watch Out For Groupthink (@The Digerati Life)
• 20-Somethings Who Invest Learn Lessons Early (@Alpha Consumer)
• SEP IRA: Self-Employed Retirement Plans (@Lazy Man and Money)

Personal Finance Carnivals

• Festival of Frugality: “The Baseball Edition” (@Personal Finance Analyst)
• The 208th Carnival of Personal Finance: Lobster Roll Edition (@Money Under 30)
• 195th Carnival of Debt Reduction (@Green Panda Treehouse)
• Dollar Frugal (@Dollar Frugal)
• Festival of Stocks #144 (@Fat Pitch Financials)
• Economy and Your Finances Carnival June 7 2009 | OneMint (@One Mint)
• The 40th Bankruptcy & Debt Carnival. (@Bankruptcy Access)

DR: How does Lending Club work?

RG: The concept is quite simple. Lending Club’s community is made up of borrower and lender members. Borrowers are good credit folks who need a personal loan for a variety of reasons. Lenders fund those loans and in return receive payments in principal and interest from the borrowers. It’s a win-win situation for all members because rates are typically lower than those paid by borrowers on their credit cards, but higher than those received by lenders for comparable investment opportunities.

DR: How do lenders fund loans? Is it done by auction or some other way?

RG: All borrowers who pass our strict credit policy are assigned an interest rate based on their credit and risk profile, varying from 7.37% to 20.11%. We then present notes associated to the loan to prospective lenders. Lenders review the “inventory” of notes and pick which ones they’ll like to invest in. Alternatively, lenders can run LendingMatch to automatically generate a portfolio with tens or hundreds of loans at a specified average interest rate. There is no bidding involved.

DR: When a lender wants to sell a loan how is this accomplished? Does he or she just set a price?

RG: A Note Trading platform operated by Foliofn is available to lender members, who just need to complete a short trading member application with Foliofn. Once that is completed, they can put their notes up for sale at a price they set for up to 30 days. Other trading members browse notes for sale and decide which notes are attractive to them based on the information available about the loan (payment history, FICO score trend, and collections log if any), and decide to buy these notes. The seller receives the purchase price minus a 1% trading fee.

DR: What kind of growth do you see ahead for Lending Club and the industry?

RG: Peer lending, and Lending Club specifically, will continue to grow rapidly and become increasingly mainstream. We have demonstrated over the last 18 months that the economics work: borrowers get more affordable access to credit and lenders earn very attractive returns. We have been gaining acceptance from the blogging community, and increasingly from mainstream press, with Lending Club being featured in CBS Evening News, NPR’s Morning Edition and WSJ in just the last few weeks. As a result, we have been growing fast in Q4 and will continue along the same trend.

DR: How is Lending Club different from other p2p lending sites?

RG: There are two key differences. First, our notes are the first and only registered with the SEC. Second, our product focuses on high quality borrowers, with a minimum FICO of 660 and an average of 708. There are other operational differences such as smaller investment amount (starting at $25 per note), an interest rate set based on credit risks (no auction model), and an effective collection process.

DR: Do you think peer to peer lending will become more popular as the public gets used to the concept?

RG: Most definitely. We have started seeing more acceptance of the concept, and it is slowly moving from the “new and interesting” category to the “part of the solution” category. As people get used to the concept, more success stories are shared, and a longer track record becomes available, mainstream will catch up on it.

DR: What are some of the features planned for Lending Club in the near future?

RG: We are focusing on 2 areas: 1) Make it simpler for Lenders to invest and keep their proceeds re-invested in the type of notes they care for, and 2) Empower borrowers to manage their loan applications and repayment process. In fact, we just pusblished some new features a few days back. You’ll see more features aimed at addressing these 2 areas being released within the next few months.

DR: Do you have any advice for beginning lenders or borrowers?

RG: To borrowers, I recommend they understand their current financial situation and are able to explain it clearly and in simple terms. Know why they are borrowing and convey how you plan to repay it.

When I speak to new Lenders, I typically recommend spreading their risk as much as possible (diversification) and understanding how to read borrowers’ credit profiles to aid them in making decisions on which notes to invest.

DR: With credit tightening will this be an opportunity for peer to peer lenders to increase the quality of the loans they fund?

RG: Absolutely. We recently increased our minimum FICO score from 640 to 660 and continue to conduct very strict credit review to ensure the community is fair to all members (borrowers and lenders).

DR: LendingClub recently added additional criteria to its interest rate calculation which in most cases will cause interest rates to go up. Can you explain what caused LC to do this? Did it conclude that its original interest rate formula did not adequately account for default risk, and if so, why?

RG: We are committed to a continuous evolution of our pricing algorithm to ensure both borrowers and lenders get a fair deal. As our portfolio gets older, we have more data to work with to identify predictors of performance unique to our members. Our pricing algorithm also reflects changes in the economic environment.

DR: Last year Prosper filed an S-1 ahead of LC, but did not suspend its lender program. It recently re-filed its S-1 and, following LC's lead, suspended its lender program while its S-1 is pending. Do you know what happened at Prosper and why LC was able to leapfrog it with its trading platform?

RG: We cannot comment on Prosper’s regulatory situation.

DR: There have been a number of p2p companies started in the last year. Do you anticipate any consolidation in the industry in the next 12 to 24 months, and if so, what is LC's strategy in that regard?

RG: Not really. It is quite early in this industry to predict any consolidations. I think there will be at least 3 or 4 very successful, public companies, and a handful or smaller players.

DR: LC currently offers borrowers a 3-year fixed rate loan. Do you have plans to offer loans on any other terms? Have you considered an LC credit card?

RG: We do have a product roadmap that considers new product extensions and additions. I’ll be able to share more details as we get closer to introducing those new products.

DR: Does LC intend to offer lenders guidance on how to value a note for sale on LC's trading platform?

RG: No, Lending Club is the issuer of the notes and as such is not involved in the way the trading platform operates. We do, however, provide very detailed information to lenders about the borrower’s FICO score trend, loan’s payment history and any collections activity, so that the selling lender member can decide how to price their notes.

For a detailed description of LendingClub's Note Trading Platform and insight on valuing loans, check out my LendingClub Note Trading Platform Review.

DR: To sign up for LC's trading platform, one must identify the name and address of their employer. You also must indicate how much you make and your net worth. Can you explain why.

RG: Foliofn is a registered broker dealer, member of FINRA and member of SIPC (Securities Investor Protection Corporation). As such, they have certain information they need to request of all their customers.

DR: Will data about loans and borrowers on the trading platform be made available to developers through an API or otherwise?

RG: Yes, that’s on the roadmap.

DR: Any last comment?

RG: Thanks for the opportunity to present Lending Club to your readers. I encourage them to try us out and send me any comments at feedback@lendingclub.com

If you'd like to give LendingClub a try as a borrower, lender or both, you can check it out here.

Lending Club's Trading Platform

To use Lending Club's Trading Platform, you must be a registered lender with Lending Club. The registration process is quick, easy and costs nothing. Click here for more details.

The idea behind Lending Club's Note Trading Platform is really quite simple. Investors holding Lending Club loans who wish to cash out can list the notes for sale on the online Trading Platform. You as the original investor set the price you are willing to accept, much like a "Buy it Now" eBay auction. We'll talk about how to determine the value of a note in just a moment. Your note is then listed on the Trading Platform for other investors to review and buy the note.

How to sell a note on the Trading Platform

Listing a note for sale on Lending Club's Trading Platform is very easy. From the Lending Club home page, you will navigate to its Trading Platform via the "Trade" tab:

The "Trade" tab takes you to LendingClub's Trading Platform, which is administered by FolioFN. You'll need to register with FolioFN the first time you visit the Trading Platform. Once registered, it's a snap to buy or sell existing notes.

The first step in selling a note is to navigate to the Trading Platform's "Sell Notes" page. From this page, you will see listed all of the loans you own that are eligible for sale. Due to the timing of Lending Club's Form S-1 registration with the SEC, only notes acquired after October 12, 2008 may be sold. Here's the loan listing for one of the loans I own:

From here, simply check the loan or loans you want to sell and click the "sell notes" button. On the next screen, you will enter the asking price for each loan you are selling. It is important to note that FolioFN does charge a 1% fee to sell your note. There is no fee to buy a note.

How to Buy a Loan on LendingClub's Trading Platfrom

Buying a LendingClub loan is as easy as selling one. From the Note Trading Platform, select the "Browse Notes" tab to view a listing of available notes. You can search the available notes based on interest rate, payment history and months remaining on the loan. For each listed note, LendingClub provides the interest rate of the note, the payment status (i.e., whether payments are current), days since last payment, remaining payments, any changes in the credit score of the borrower, outstanding principal, accrued interest, the asking price for the note, and the markup or discount of the note (more about the markup/discount in a moment):

Buying a loan is as simple as selecting the notes you want to buy. But the real question, whether you are buying or selling a note, is how to value a loan.

How to Value a Loan on LendingClub's Note Trading Platform

When valuing a note for resale, we have to ask one very important question: Why would I buy this note at the listed price on the Trading Platform rather than investing in a brand new loan on LendingClub? And the first step in answering that question is to compare the interest rate on the note for sale to the interest rate we would earn if we invested in a new loan to a borrower with the same credit profile. To see how this works, we'll use the first note listed (as of 1/5/09) as an example. Here's what the loan listing looks like, followed by the detail of the loan:

Notice that the borrower here as a credit category of B4 and an interest rate on the note of 11.49%. So how does that compare to the interest we would earn on a new B4 loan today? Scanning LendingClub's listing of available new loans, I found a B4 loan listed at 11.89%. So by investing in a new B4 loan, we can actually do slightly better than if we purchased the loan advertised above.

If you'd like more information on how LendingClub calculates interest rates, check out this article comparing LendingClub and Prosper.

So if we were selling this note, what might we do to encourage an investor to buy the loan? We'd do exactly what bond traders do on Wall St. We'd sell the note at a discount. In this case the principal balance is $25 plus accrued interest of $0.02 for a total balance of $25.02. So we might list the note at $24.90, for example, to make up for the slightly lower interest rate as compared to a new loan today.

You may have heard the expression that as interest rates go up, bond prices go down. And as interest rates go down, bond prices go up. The exact same thing is true here. Now the loan above, rather than selling at a discount, is being offered at a 1.98% premium. Why? Frankly, it is probably because the seller thinks he or she can sell the bond at a premium. Of course, I can't tell you what you should do, but I would never buy that loan at its current asking price. The loan has not been aged (i.e., it was just issued so there is no history on how timely this borrower pays back the loan), and I could get a higher interest rate on a similar loan by investing in a new note.

Final Thoughts on LendingClub's Note Trading Platform

LendingClub's Note Trading Platform places the person to person lending site in the #1 position, in my opinion. It is the only social lending company to enable investors to resell notes. This adds liquidity to the investment as investors can sell their loans if they need to cash out. From an operational perspective, it does add some burden on LendingClub. It now must registered its debt securities in every state, a process it is working on now. As such, investing in a note is limited to residents of the states where LendingClub's registration has been accepted. Eventually they will be in all 50 states, but not yet. In addition, there are income and asset requirements to becoming an investor, which have to do with certain securities regulations. And LendingClub now has certain periodic filing requirements with the SEC.

All of that said, however, the trading platform was an absolutely critical next step in social lending. And LendingClub managed to cross the line first.

If you'd like more information about LendingClub, or to register as a lender or borrower, you can click here.

LendingClub Files an Amended S-1

In June, LendingClub filed a Form S-1 to register $600,000,000 in debt securities. As is typical for such a filing, the SEC's Division of Corporation Finance ("Corp Fin" for short) reviewed the filing and likely issued a comment letter back to LendingClub. Corp Fin's comment letters are not made available to the public until after the comment process is complete.

In response, LendingClub has filed an Amended S-1, likely responding in part to a Corp Fin comment letter. For those anxiously awaiting the resumption of LendingClub's lender program, this filing is good news as it brings the social lending site one step closer to going "effective," the term used when a registration statement clears all the SEC hurdles. In fact, depending on the scope of Corp Fin's comments and how well LendingClub has done in responding to them, the company's S-1 could go effective very soon.

In sharp contrast, Prosper filed an S-1 registration statement with the SEC back in October 2007. The registration statement has neither been amended nor gone effective, raising significant questions about Prosper's future plans with its public debt offering. Regardless, it appears that LendingClub may be the first peer-to-peer lending site to offer a resale platform.

LendingClub Discloses a New Interest Rate Formula

The big news, at least for borrowers and lenders, is LendingClub's disclosure of a new way to calculate interest rates. Recall that Prosper and LendingClub set rates differently. Prosper's rates are based entirely on an auction style bidding process similar to EBay. In contrast, LendingClub sets interest rates itself based on certain credit criteria of the borrower.

Until its recent disclosure, LendingClub calculated interest rates based on a borrower's FICO score, debt-to-income (DTI) ratio, and amount borrowed. While the method of calculating the interest rate can appear daunting, you can read my detailed description of how LendingClub sets interest rates.

In its Amended S-1, LendingClub disclosed that under a new formula, it will also use several other credit markers in calculating interest rates. Specifically, LendingClub will factor in a borrower's number of open accounts, the number of credit inquiries in the last six months, how much of a borrower's available credit is used up, and length of credit history.

Under the new formula, for example, a borrower with less than three open credit accounts will be declined for a loan. With the exception of borrowers with exactly five open credit accounts, all other borrowers will have their interest rate increased by varying amounts depending on the number of open accounts. Likewise, a borrower with 11 or more credit inquires in the last six months will be declined for a loan. Fewer inquiries generally will not disqualify a borrower, but will increase the interest rate unless the number of inquiries is zero to three.

It will be interesting in weeks to come to understand why LendingClub has made this change, particularly given that many of the new criteria are already considered in arriving at a borrower's FICO score.

If you would like to read all the details for yourself, you can check out LendingClub's Amended S-1.

Here's the full text of the email I received today:

Lending Club has started a process to register, with the appropriate securities authorities, promissory notes that may be offered and sold to lenders through our site in the future. Until we complete the registration process, we will not accept new lender registrations or allow new commitments from existing lenders. We will continue to service all previously funded loans during this period, and lenders will be able to access their accounts, monitor their portfolios, and withdraw available funds without changes.

The borrowing side of our site will remain generally unaffected by this registration process; borrowers can continue to apply for loans and new loans posted after April 7, 2008, will be funded and held only by Lending Club.

Until the registration process is completed, the company will undergo a quiet period and will not be able to respond to press and other inquiries about Lending Club or the registration process during that time.

Q&A:

Q1. What about money I have begun moving, but is still in transit to Lending Club?
A1.1. If you are in the process of verifying your bank account, you will be able to complete that verification but will not be able to add new funds
A1.2 If you have initiated a transfer, the funds will be displayed in your Lending Club account balance as soon as those funds are available.
A1.3 If you have uncommitted funds, you may request that Lending Club return those funds via the same method used to load the funds. For example,
If you have initiated an ACH to add funds, these funds will be transferred into your Lending Club account but you will not be able to lend these funds out. You can go into your Lending Club account once the ACH transfer has been completed and withdraw funds back into your linked bank account..
If you've wired funds into your Lending Club account and have not yet committed these funds into loans, you can send a request to support@lendingclub.com for us to wire these funds back to you at no charge.
If you've sent funds by check, and have not yet committed these funds into loans, you can send a request to support@lendingclub.com for us to send you a check by mail for the same amount at no charge.

Q2. What about referrals?
A2.1 The current referral program is terminated. If you have referred someone who has already signed up as a lender or a borrower, or if you have been referred by someone and have already signed up as a lender or a borrower, you will be receiving your referral payment within the next few days.

Sincerely,

Patrick Gannon
Senior Vice President
Lending Club
440 N Wolfe Road
Sunnyvale CA 94085
www.lendingclub.com

Lending Club's move makes me wonder if there isn't something more here than simply registering debt. I'll be looking for its SEC filings and will report back what I find. Until then, if you're looking to invest in P2P loans, Prosper is now your primary choice.

If you think Prosper and Lending Club set interest rates the same way, think again. In fact, how they set interest rates is fundamentally different.

Prosper versus Lending Club

Prosper follows an Ebay auction style format, where the interest rate is set by the lenders through bidding. Lending Club sets the interest rate based on a formula, and lenders either accept that interest rate or not; there is no bidding, much like Craig's List. Whether you are a lender, borrower, or both, understanding the difference and how each site sets interest rates is critical. So in this SmackDown between the two Peer-to-Peer Lending giants, we'll look at how each sets interest rates, and then discuss how to evaluate which one is best for you.

How Prosper Sets Interest Rates

Prosper uses an auction style format to determine the interest on each of its loans. On EBay, prices start low and are bid up. On Prosper, the interest rate starts high and is bid down. When borrower's create their loan listing, they must include the highest interest rate they are willing to pay. Much like EBay suggests starting with a low price to attract bidders, Prosper recommends starting with a high interest rate to attract lenders. Prosper describes this approach in its "Create a Loan Listing" help section. Prosper also will recommend a starting interest rate if you are unsure where to begin.

Lenders who bid on the loan must enter the lowest interest rate they are willing to accept. This interest rate is not disclosed to the borrower or other lenders. As more lenders bid on the loan, the interest rate comes down. Bids are ordered from lowest interest rate to highest, and by time of bid in the case of a tie. The loan is funded beginning with the lowest bids, and the final interest rate is determined by the last bid used to fund the loan. Prosper offers a nice example of this process in its Bid History help section.

What all of this means is that Prosper does not set the interest rate, the borrower and lenders do. Lending Club is a whole different story.

How Lending Club Sets Interest Rates

Lending Club sets the interest rate for the borrow and lenders based on a credit grade. The credit grades range from A to G, and each letter grade has a sub-grade ranging from 1 to 5. For each grade and sub-grade, Lending Club sets what it calls a base rate, which currently ranges from a low of 7.05% for grade A to 7.55% for all other grades. Lending Club then adds to the base rate a rate equal to two times the average default rate for the given credit grade. For example, the average default rate for A1 borrowers is 0.16%. Lending Club doubles that rate, adds it to the base rate of 7.05%, to arrive at the final interest rate for A1 borrowers of 7.37%. In contrast, the average default rate for a D5 borrower is 3.16%, which when doubled and added to the base rate of 7.55%, nets a final interest rate of 13.87%. To determine a borrower's credit grade, Lending Club uses the following 3-step formula:

Step 1: Each borrower is given an initial credit grade and sub-grade based on their credit score. As an example, here are the credit scores that will result in an initial credit grade of either A or B:

Step 2: LendingClub adjusts the credit sub-grade based on the borrower's debt-to-income (DTI) ratio. A DTI ranging from 0 to 12.99% results in no adjustment. A DTI of 29% results in a downward adjust of 16 sub-grades. For example, an A1 borrower based on credit score would by lowered to a D2 credit grade if they had a 29% DTI. Here's the Lending Club table that shows how a borrower's DTI will affect their credit grade:

Step 3: Finally, LendingClub makes another adjustment to the credit grade based on the amount of the requested loan. The loan amount is divided by what Lending Club calls a loan guidance limit, which is different for each credit grade. For example, the loan guidance limit for C borrowers is $10,000. If the requested loan is $7,500, the loan guidance ratio would be 75% (7,500 / 10,000), which would result in a further decrease in the sub-grade by 3.

How to Determine Which is Best for You

Borrowers want the lowest interest rate they can get. Lenders want the highest interest rate they can get, given the risk they are assuming. Because Lending Club sets interest rates using a published formula, it�s easy to determine in advance the interest rate for a given loan. Once the Lending Club interest rate is known, it�s a simple process to compare it to the interest rate Prosper auctions are generating for loans of a similar risk profile. Let's use this approach to compare two of my Prosper loans with the interest rate I would have received if I had bid on a similar loan at Lending Club.

I have five loans on Prosper, all chosen using Prosper's Portfolio Plans. Some of the loans can't be compared to Lending Club either because the DTI is above 29% or because the credit score is below 640, two requirements all Lending Club borrowers must meet. But I can compare two of the loans.

Loan No. 1

Credit Grade: C. A credit grade of C on Prosper means the borrower has a credit score somewhere between 640 and 679. It's unfortunate that Prosper doesn't give lenders a better idea of a borrower's credit score. From a credit risk perspective, there is a HUGE difference between a credit score of 640 and 679.

DTI: 11%

Loan amount: $4,500

Final interest rate: 11.50%

Using the formula on LendingClub, we can determine that this borrower's starting credit grade would have been somewhere between a D5 and a B5. Why such a big range? Because Prosper doesn't give us a more precise indication of the borrower's credit score. A DTI of 11% would not have resulted in any adjustment to the credit grade. The loan amount of $4,500 would have resulted in a reduction of the sub-grade by 1 or 2 sub-grades, depending on the borrower's initial credit grade. From this information, we know that the interest rate this borrower would have paid at LC is somewhere between 11.03% (sub-grade C1) and 14.18% (sub-grade E1). So the interest rate I'm earning at Prosper is within the range I would have earned at Lending Club, although there is a real possibility I would have earned more at Lending Club, depending on the borrower's actual credit score.

Loan No. 2

Credit Grade: AA (credit score of 760 and up)

DTI: 25%

Loan Amount: $9,500

Interest Rate: 8%

Running these numbers through the LendingClub formula yields an interest rate of between 12.29% (sub-grade C5) and 12.61% (sub-grade D1). Again, we have a range because of the somewhat less precise information Prosper offers about a borrower's credit score. Regardless, the difference in the interest rate is dramatic. Why?

I believe the reason is two-fold. First, there are a lot of lenders bidding on Prosper loans at the moment, which brings down the interest rate. Second, Prosper lenders are underestimating the importance of DTI. This borrower's DTI of 25% is significant, particularly given that DTI does not include rent or mortgage payments. His AA credit grade certainly reflects a good credit history, but a DTI of 25% raises a significant risk that his cash flow will be insufficient to service the loan.

Final Thoughts

Whether you are a borrower or lender, the starting place should be to determine the interest rate you would pay or receive at Lending Club. As a borrower, there would be no reason to pay more than this rate on a Prosper loan. And as a lender, there would be no reason to accept less. The fees Prosper and Lending Club charge should also be considered. Lending Club's fees for borrowers (.75% to 2%) are slightly lower than Prosper's (1% to 3%). In contrast, Prosper's fees to lenders are lower than Lending Club's for loans made to AA borrowers (0% at Prosper compared to 1% at LC). Lender fees for all other loans are the same for both at 1%.

For borrowers with a DTI below 11%, I think interest rates between the two sites will be very competitive. As the DTI moves higher, however, I suspect the rates will be better for borrowers at Prosper, and better for lenders at Lending Club. Because Prosper rates are set based on lender bids, there is always the very real possibility that interest rates at Prosper will not reflect the default risk presented by the borrower. Furthermore, Prosper bids will be influenced by factors not relevant to credit risk, such as how the borrower presents himself or herself in the loan listing, whether they include their dog or child in the photo, whether they are attractive, and so on. These irrelevant factors will lead to opportunities for both borrowers and lenders that will sometimes favor Prosper and at other times favor Lending Club. At present, I suspect that many Prosper lenders are underestimating the risk of default, which results in better interest rates for borrowers at Prosper, and better interest rates for lenders at Lending Club.

If you'd like to sign-up to be a lender or borrower, you can use the following links:

• Lending Club.
• Prosper--Update: As noted above, Prosper has suspended its lender program for now. We will update this post when Prosper's lender program resumes.

Image Credit: Wolfgang Staudt

Creating a lending account and logging into Prosper

If you are not already a member of Prosper, the first step is to join. Joining Prosper takes only a few minutes and the screens are very easy to follow. You will need your social security number and checking account information. Prosper links to your checking account so that you can transfer funds to and from your Prosper account. If you use this link to join as a lender, Prosper will give both you and me a $25 bonus. As you may know, I donate 50% of my bonus (and all other blog revenue for that matter) to charity. Anyway, it's a great way to get started. Once you've joined and funded your account, when you sign back in the screen will look like this:

Prosper's Portfolio Plans

Toward the bottom left of the screen is a red ellipse that I added to the screenshot to highlight my current balance: $225. The red rectangle toward the top highlights the link to begin using Prosper's Portfolio Plans. Prosper has four plans: Conservative, Balanced, Moderate and Aggressive. Each plan consists of a number of what Prosper calls Standing Orders. A standing order allows you to bid automatically on loans based on criteria you establish. For example, you could create a standing order to bid on all loans from grade AA borrowers with a debt-to-income ratio of less than 20% who are seeking loans of no more than $10,000. Prosper's Portfolio Plans are a series of standing orders created by Prosper with different risk profiles depending on the types of loans you want to make. Here is what the Portfolio Plan page looks like:

Under each portfolio name is a link that will give you details about the standing orders that make up that portfolio. The conservative portfolio, for example, is comprised of four standing orders. Here's a view of the first two:

You first see a summary of the estimated returns, which is the average bid rate less estimated losses and expenses. For the conservative portfolio, the estimated return is currently 7.79%. Below that you'll see two of the four standing orders that comprise the conservative portfolio. Similar information is available for each portfolio.

So how did I chose my portfolios

The question here is whether the risks associated with each portfolio are reflected in the interest you'll earn. Frankly, it's difficult to make that assessment with the data we have. Financial institutions have terabytes of data that allow them to analyze borrowers and default trends in unimaginable ways. We don't have that, and simply noting the higher interest rate for the riskier portfolio really doesn't tell you much. To me, the real test of these portfolios will come when the unemployment rate rises substantially. So my approach was twofold.

First, I see no reason to take significant risk with debt instruments. I invest in bonds and view my Prosper account as an extension of that. I invest in bonds for consistency and some level of security. Lending money to borrowers with really shaky credit and a high debt-to-income just doesn't make sense for me. So I put $125 in the conservative portfolio. I do, however, like the opportunity to earn a little bit more without taking undue risk, so I put $50 in the balanced portfolio and $50 in the moderate portfolio. I also instructed Prosper not to give any one borrower more than $50. This further helps diversify my risk.

Now at this point you may be wondering why I spread $225 so thin. First, I hope this account grows substantially. I've invested the money in portfolios that I think would be appropriate if I had $5,000 to lend. Second, with Prosper's Portfolio Plans, it's easy to do.

There's one final point to note. I've submitted my portfolio plans with exactly $225. That raises the question whether I need to go back and create new plans every time I add money to prosper. The answer is no. You can allocate more money to a portfolio plan than you have in your Prosper account. As new money comes in, Prosper will lend your money according to your portfolio plan. You can check out Prosper's Help page for more information on Portfolio Plans.

Watching your bids

After you submit your portfolio plan, assuming you have funds in your Prosper account, the bidding is almost instantaneous. Literally from the time I submitted my bid, wrote the above paragraph, and then checked my account, I had four bids, one of which is completely funded. My average interest rate is 13.49%, although that could go down as more bids are received on the loans. Remember, just because a loan is fully funded doesn't mean the bidding is over. New bids can come in that drive down the interest rate.