How I Overcame My Fear of Lending Money on Prosper.com

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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.

  1. You set basic or detailed investing criteria.
  2. Quick Invest will find loans that meet them.
  3. 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.

Signing up to borrow or lend money with Prosper

If you’d like more information about becoming an investor or borrower, you can visit the official Prosper website. You can also check out LendingClub’s official website, too.

Published or Updated: August 18, 2014
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. Jeremy says:

    Good info. I signed up once but never went back. Seemed to much work. I might have to give the portfolio deal a try though.

    • DR says:

      Jeremy, the Portfolio Plans convinced me to give Prosper a shot. Looking at individual borrowers was just too much work. There were alternatives, but I really like the Portfolio concept.

  2. Best Advice on Debt says:

    While I must admit it is intriguing, I can’t justify putting my money on the line like that. Maybe one day I’ll make the leap but not right now.

    • DR says:

      That’s exactly how I felt a few months ago. I’ve obviously changed my mind, but putting your money in other investments is certainly a reasonable choice. Best of luck.

  3. George Adams says:

    DR, from a Christian perspective, did you find any conflict between joining prosper.com as a lender and the number of verses in the Bible that warn people not to be lenders, at least in certain circumstances? I’ve been interested in prosper.com for a while, but I haven’t done enough research on biblical guidelines for lending to know whether it’s a good idea for me or not. (I got a bit of help from http://www.crown.org/LIBRARY/ViewArticle.aspx?ArticleId=282) I’d be interested to hear how you worked through the issue for yourself.

    • DR says:

      George, that’s a great question and one I’ve given considerable thought to. Of course, lending was common in the Bible, and the OT even describes when debts should be forgiven. In the NT, the concept of forgiving a debt is used as a teaching device (see, for example, Matt. 18). Perhaps I’ll raise this question in an article and see how the reader’s respond.

  4. Patrick says:

    I recently signed up for a Prosper account as well, and my first money transfer should arrive there tomorrow. I plan on writing about it – I think it is an interesting way to add to your portfolio. Like you, I plan to start small, and will probably go with a balanced lending portfolio. I’m interested to hear how this works out for you.

    • DR says:

      Patrick, me too. I think the Portfolio Plan was a smart move by Prosper.

  5. kick_push says:

    i’m confused as how a lender gets paid the interest.. do they get paid monthly as the lender makes payments?

  6. kick_push says:

    i’m confused as how the lender is paid interest..

    do they get money monthly as the person who asked for the loan makes payments? or is it a lump sum?

    • DR says:

      kick_push, each loan is amortized over three years, and require monthly payments. So each month’s payment represents both some interest and return of the money loaned.

  7. Prosper is safe, it just needs to grow a bit. Default rates are a bit high at the moment, but this is improving. Definitely believe in the concept.

  8. Kappalex says:

    I’ve been a prosper lender for over a year now and its great! It has a higher return than my savings account and not as high of a risk as investing in stocks (if you are smart about who you lend your money to). My only advice is do not get greedy and spread your bids over a number of loans. Also there is a website lendingstats that is a good way to look at other lenders portfolios and borrowers loans. Hope this helps!

    • DR says:

      Kappalex, thanks for the advice. And I agree that lendingstats.com is a great site to check out. Very interesting data and well organized.

  9. ira01 says:

    I have been a lender on Prosper since March 2007, with about $2,400 invested. Although my projected ROI is currently about 8%, I stopped lending in October for a variety of reasons all linked to Prosper’s management. Basically, the best way to summarize Prosper is that it is a wonderful concept, executed horribly due to the incompetence and arrogance of management.

    There are too many serious problems with Prosper to list here, but brief review of prospers.org, which is the largest Prosper forums, will provide anyone interested with a long list. Here are a few:

    1) The default rate on Prosper is MUCH higher than advertised. Chris Larsen, Prosper’s CEO has been quoted in recent news articles saying the default rate is 2.7%. While perhaps technically accurate using Prosper’s narrow definition of “default,” this is utter balderdash from any real perspective. Prosper only counts a loan as defaulted when it sells it to a junk debt buyer for pennies on the dollar. However, Prosper currently has such sales only quarterly, so it is not uncommon for there to be many loans that are 5, 6, 7, or more months late. Historically, loans almost never come back from being even 3 months late, so all of these loans are defaults in everything but name. Moreover, Prosper calculates its official default rate as the number of defaults divided by the number of loans, but because many loans are too new to have defaulted even if the borrower never made even the first payment (which happens far more often than you might think), this also tends to understate the default rate. So far as can be seen, the real default rate — based on several different analyses — appears likely to be close to 20%.

    2) One of the contributing factors to issue #1, is that Prosper’s collections are anemic. When a loan turns 1 month late it is turned over to Prosper’s collection agency, but historically, only around 15% of loans in collections are brought current. There have been many anecdotal stories by late or defaulted borrowers on Prosper’s old forums that they either were never contacted by the collection agency, or the contact consisted of an email or 2 and maybe a phone call or two. Prosper’s own newly-hired VP of Collections admitted that the call logs from the collection agency showed that they were repeatedly trying to contact borrowers at the same time of day, such as between 3-5 pm, so if the borrower worked during the day, no contact was made.

    3) Very little information about the borrowers is verified by Prosper. Prosper selects a subset of fully-funded listings to verify employment and income, but many listings become loans without such verification. Prosper has already had to repurchase about $400,000 of loans under its ID-theft guarantee, meaning that Prosper let many fraudulent loans through its systems. Indeed, there is one case (identified by a diligent forum member) where one person obtained a dozen loans from Prosper under different identities. After the forum member outed this on the old forum, Prosper repurchased the loans and sued the borrower in Los Angeles Superior Court to get its own money back. However, there is substantial doubt among the lending community that Prosper tries very hard to identify ID-theft loans, because when it does, it has to repurchase them from lenders. There was one case where a different forum member conducted some excellent detective work (the borrower included enough information in the listing to enable their identity to be discovered), including determining that the “borrower” of a Prosper loan was the victim of ID-theft from other creditors, and he actually spoke with the NYPD detective investigating the case. The forum member gave all this information to Prosper, including the name of the detective, and for months Prosper apparently did nothing (the NYPD detective later told the forum member that he had NOT been contacted by Prosper). Only after a major firestorm erupted on the forum about this, did Prosper repurchase the loan from lenders (after it was about 10 months old, as I recall).

    3) Although Prosper has funded a number of fraudulent loans, it has also cancelled a number of legitimate loans, apparently through incompetence. One such loan involved the brother of a well-respected Prosper lender and very active forum participant. After claiming that faxed documents were illegible and then that Prosper couldn’t open a .pdf file, it cancelled the fully-funded listing with no opportunity for the borrower to resubmit the documents. There have been many other Keystone Kops situations involving Prosper’s verification, including one case where Prosper’s telephone system apparently couldn’t connect to an 888 number (the employer of a borrower), so the loan was cancelled, even though the Prosper employee was able to reach the company on his personal cell phone.

    4) Related to issue #3, Prosper’s customer service is terrible. Often, they let the phone just ring and ring without answering it. When you send an email, the response is often irrelevant boilerplate. Lenders used to provide a lot of Prosper’s customer service for free on their old forums.

    5) Prosper’s advertising is highly misleading in many ways, if not downright fraudulent. They overstate interest rates in ads directed to lenders, and understate them in ads directed to borrowers. Prosper was caught once apparently having photoshopped a screen shot of an actual listing in an advertisement about the rate (changing the actual rate to something more beneficial). Also, Prosper has repeatedly sent out mass email ads featuring borrower and lender testimonials that were quickly proven to be false. After the first time, Prosper admitted that it hadn’t verified the facts claimed by the person, and said it would do so in the future. But whoops, they promptly did it again (in a different testimonial) in the next ad.

    6) Prosper used to have a vibrant community on its official forums, with about 400,000 posts. These forums were an amazing learning experience for lenders, so that new lenders could avoid the mistakes of their predecessors. Prosper banned me from the forums and from lending (although I had already publicly announced that I had stopped lending due to Prosper’s mismanagement) because I sent a bunch of PM’s to new lenders alerting them to the existence of Prosper’s own official forums. Then, the day before Thanksgiving, Prosper deleted its entire forum with no notice, in an effort to hide the truth from new lenders. It then replaced the old forums with a super-moderated version that is completely useless (every post must be approved before being posted, which often takes days even when the moderator lets it through, which is rare except for cheerleading posts).

    7) When another forum member made an archive of the old forums available on prosperreport.com, Prosper had its lawyers send a threatening letter seeking to take the domain away on baseless trademark, unfair competition and cybersquatting grounds. Undoubtedly, Prosper figured this person would cave in and take down the site. Instead, he retained a lawyer from Public Citizen, who responded to Prosper’s letter by explaining how Prosper’s claims are entirely without merit. Both letters are posted on the site. Prosper has yet to respond.

    ( 8) Prosper has also misappropriated thousands of dollars of lenders’ money by charging its servicing fee on loans that were more than a month late, contrary to Prosper’s own legal agreements. This too was discovered by yet another forum member. Prosper admitted that its action was “in error,” but only recently returned this money to lenders despite having promised to do so months ago.

    (9) Another significant issue is whether Prosper will even survive as a company for the three-year term of its loans. As can be seen on Lendingstats.com, loan originations have been essentially flat for the last six months, and Prosper’s CEO has admitted that loan originations need to increase 400%-500% in order for Prosper to turn a profit. Given that, clearly the outlook is troubling. Although the Prosper Lending Agreement specifies that if Prosper goes out of business the loan servicing will be taken over by another servicing company, there is no guarantee that any such company can and will be found, or that the transition will go smoothly, or that the new company won’t require higher fees in order to do the servicing.

    The above issues are really just the tip of the iceberg. If anyone is considering lending on Prosper, do your due diligence. Read prospers.org, and check out the actual performance of lenders on lendingstats.com. For example, you will see that looking at ALL moderately seasoned lenders on Prosper (those with >20 loans and >6 month average loan age), the median projected ROI is around a mere 4.5%. That is about what E-Loan is offering on its FDIC-insured, 100% liquid savings accounts. And the tax treatment of Prosper loans is also worse (for one thing, you have to pay income tax on the servicing fee that you pay Prosper due to the way it is collected).

    Caveat lender!

  10. c-had says:

    Great post ira01. I remember getting all excited when I first starting lending at prosper in late 2006. That was until the defaults started… 2 of my 5 loans defaulted, one was even a “B” Credit rating. My 3 remaining loans look like they might break me even if the borrowers continue to pay, but hey, I didn’t sign up to break even.

    I would recommend prosper if you want a hobby and don’t mind making a poor return or worse, losing money. Most people that stay on prosper get really into the stats and “game”.

    I have decided to just invest following more of the Scott Burns philosophy, diverse funds with low fees. Invest and forget about it. I will not be lending on prosper again.

    • DR says:

      c-had & ira01, thanks for your perspective. It’s interesting to see that some do really well with P2P lending, and others do not. I do think we need to be careful about drawing conclusions based on a relatively small data set. That said, it’s important to remember that P2P lending involves unsecured consumer credit. This shouldn’t be compared to corporate bonds or other less risky debt instruments. Unsecured consumer debt carries with it a lot of risk, both of default and interest rate risk (although at a 3 year term, the interest rate risk is manageable). c-had, I take your approach to investing with the vast majority of my portfolio. I have enjoyed lending on Prosper and Lending Club, but it will always represent a very small percentage of my investments.

  11. Richnpoor says:

    I was considering the comments you made about the level of risk you have in some of your other investments.
    Personally I currently have about 20% of assets in a precious metals fund. Originally it was only about 7 % and within a month i was staring at a 15% loss( I have a remarkable gift for investing just prior to a correction), Reexamined my analysis several times was sure gold was bullish and committed another 5% of assets to a losing position. It came roaring back and Im up 8% (a 23% swing).
    I recently put about 2% in a BRIC fund…not the most conservative investment by far. International funds, small cap funds my broker says Im not risk tolerant Im risk immune. I moved 80 % of assets into ultra short term bonds just prior to the big correction that started middle of October (um…yeah I was timing the market and got it right). But I gotten plenty of trades wrong in my life.
    Despite this apparent risk tolerance a $250 unsecured personal loan just gives me the jitters. My portolio moves more than that on most days, so its not a huge sum.
    Maybe its the fact that 10 years ago I stopped lending money to family. If I have it and it wont negatively impact my family I give the money as a gift, if I get it back im pleasently surprised (more often I dont, but it doesnt bother me the way it used to). I like some level of distance in my investment, I dont want social interaction. I invest to make money and I prefer to base my decisions on fundamentals, technical analysis, not on how much someone’s “story” appeals to me.
    Im not a complete risk it all on one roll of dice guy as I may seem, the money I kept in the market during the correction was in a Utility fund (yeah like your grandmother owns) I just ‘went long the market’ with a small % of my portfolio and I put that in a very conservative Dividend/Income fund and I only put in a small percentage. The charts seem o indicate we had a ‘Panic Bottom’ around jan 22nd volume spiked to the downside and the dow has crossed above its 20 dma and its 50dma in the past few days. Bernake seems determine to cut rates to 0 if neccessary (inflation will come but the market will party til it gets here)
    Anyone who’s in this market in spite of the subprime mess (and its not done yet) who buys when fannie mae loses 4 billion is risk tolerant but I still wouldnt lend my sister $300 and expect it back
    ;-)~

  12. Darrel says:

    I think I’m going to give p2p lending a shot. I will start with a small amount and see how it goes. Thanks for the information.

  13. Jake says:

    I think P2P lending is an excellent idea even though I have yet to take the plunge. The free credit score is nice though, but I’m not likely to jump in just yet. Call me crazy.

  14. djmike805 says:

    I have been a Prosper lender for over a year and have not had a single loan be late or become default. I have over $2000 invested in “AA” and “A” borrowers with maybe 1 or 2 “B” grade borrowers. For those who have had loans default or become late I guarantee if you only make loans to the top 2 credit grade borrowers you will see the defaults and late payments nearly vanish. I have only two bits of advise:
    1. No more than $50 to any borrower.
    2. No loans under “A” credit rating, period.
    Feel free to email me if anyone can prove this method wrong…

    • DR says:

      djmike, thanks for the info. I too have yet to have a default, although I’ve not invested as much as you.

  15. Matt says:

    DR – it has been a few years since you wrote this and I am wondering if your opinions on P2P lending have changed with more experience. Any feedback would be appreaciated.

  16. Frank says:

    Prosper.com is a great way to earn the kind of returns that banks have for the past 100 years, investing in personal loans. Now it does look like the credit score chart above is outdated since Prosper.com only let borrowers in who have at least a 640 credit score, this has been the case since July 2009. See, since July 2009, Prospers returns have been phenomenal and that’s because they made some great key changes. One of them was moving up the required credit score to get in from a 540, to a 640, huge 100 point jump there. In addition, they tightened up their risk assessment model which has been constantly refined and is exceptional. Lastly, they started in December of 2010 to start assessing the borrower’s interest rates themselves, no longer letting lenders bid down the interest rates in a auction format. Because of all these changes they have made, Prosper has been averaging 10.02% in returns for their lenders since July 2009, pretty impressive. Think about it this way guys, instead of banks having your money and giving you a small return 1-2% and loaning it out to someone else at 9%, Prosper lets you play banker and enjoy a nice return on credit worthy borrowers.

    • Rob Berger says:

      Frank, thanks for your comment. I have updated the article.

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