I‘ve invested in the stock market for more than 15 years. I own mutual funds that invest in junk bonds, emerging markets, micro cap stocks and other very risky investments. I’ve lived through severe market downturns like we saw in 2000-2002. I’ve watched my portfolio balance plunge, all the while holding steadfast with my investment choices.
So why then was I so afraid to lend a few hundred bucks through Prosper? And more importantly, how did I overcome my fear of peer-to-peer lending?
What is Prosper and P2P Lending
Person-to-person lending brings together borrowers and lenders. The idea is take out the middleman (i.e. banks), so that borrowers can get lower rates and investors can get higher rates. Prosper is one of the leading P2P lending companies.
If you need to borrow up to $25,000 and have a credit score of at least 640, you can sign up at Prosper and submit an application. Once your application has been approved and you complete a loan listing, your loan request is then made available to all of the lenders on Prosper. Here’s how Prosper describes qualified borrowers:
A new Prosper borrower must be a U.S. resident in a state where Prosper loans are available, and must have a bank account, a Social Security number, and a credit score of at least 640. Prosper uses Experian to obtain credit scores. Depending on their qualifications, approved borrowers can request unsecured loans from $2,000 to $25,000.
When Prosper first came on the scene, interest rates were actually set based on bidding by potential lenders. That process didn’t work so well, and today Prosper sets the interest rate of each loan based on two factors: (1) the borrower’s FICO credit score, and (2) a proprietary Prosper Score. Together, these two scores generate what is called a Prosper Rating.
The interest rate for each loan is then based on the Prosper Rating, as well as the length of the loan (1, 3 or 5 years) and whether the borrower as obtained loans from Prosper in the past. While market conditions also affect interest rates, they generally range from about 5.5% for the best qualified to as high as 35% for those less qualified.
So why did lending money at Prosper concern me?
I viewed it as too personal. Buying a mutual fund is a very impersonal method of investing, at least for me. I thoroughly evaluate each fund I own and then make the best decision I can. But I’m evaluating companies, not individuals.
As I browsed through the loan listings at Prosper, however, each listing came with the borrower’s picture and a description of why they needed a loan. I kept wondering how in the world I was supposed to determine whether a specific borrower would repay the loan. And even for borrowers with good credit, I also wondered why they were coming to Prosper for a loan in the first place. Why not go to a bank? Was there some problem with their credit history that prevented them from borrowing through more traditional channels? And if so, why should I lend them my money?
How did I overcome my fear of lending money at Prosper?
To be completely honest, I haven’t. At least not entirely. But I have put my concerns in some perspective. First, P2P lending has grown in popularity over the last few years. Simply put, individuals borrow from Prosper because they can obtain better rates than borrowing through more traditional channels. These lower rates are the result, in part, of lower transaction costs.
Michelle Singletary wrote an article in the Washington Post called The Pros and Cons of Social Lending. According to her article, P2P lending will grow to $159 billion (yes, billion) over the next five years. Second, I’m not investing my life savings. I’ve started with $2,500. I don’t want to lose that money, but it wouldn’t break the bank, either. And finally, I’m taking advantage of a new tool Prosper is offering called Quick Invest.
Prosper’s Quick Invest Tool
For me, Prosper’s Quick Invest tool makes the process a whole lot less personal. You may enjoy the personal aspect of P2P lending; many people do. For me, I’m concerned that I’ll let my emotions make my investing decisions, which is never a good idea. With Quick Invest, I’m bidding on a portfolio of loans within a certain credit score, not individual loans. It also makes the process a lot faster. Here’s how it works.
- You set basic or detailed investing criteria.
- Quick Invest will find loans that meet them.
- Simply confirm the entire set of loans to invest your funds immediately, Or review each individual loan to decide whether it’s right for you.