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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
Perhaps the most significant difference between Prosper and Lending Club is borrower qualifications. Lending Club requires a higher credit score, lower debit-to-income ratio, and longer credit history. In contrast, Prosper has developed a proprietary scoring formula called the Prosper Score. Together with a borrower’s FICO score, each applicant is assigned a Prosper Rating that determines interest rates.
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
There are several ingredients that go into Prosper’s interest rates. As an initial matter, borrowers must satisfy the following requirements:
- They must be U.S. residents;
- They must have a a FICO credit score of 640 or higher (if you don’t know your score, you can get it at the FICO website for a small fee);
- They must have a bank account; and
- They must have a social security number
Once a borrower meets these requirements, Prosper determines rates based on the following:
- Prosper Rating
- Expected Loss
- Loan term
- Economic environment
- Competitive environment
Of these factors, the Prosper Rating is the most significant. It comprises two scores, a borrower’s FICO score and Prosper Score. The Prosper Score was devised by Prosper, which claims it gives a more precise picture of credit worthiness than does a traditional credit score.
The Prosper Score was developed using Prosper loan data and attempts to estimate the likelihood that a loan will go 61+ days past due. The score, which ranges from a low of 1 to a high of 10, is based on the following factors:
- Number of trades
- Number of delinquent accounts
- Number of inquiries
- Number of recently opened trades
- Amount of available credit on bankcards
- Bankcard utilization
Each borrower is then assigned a grade which, along with the loan term (3 or 5 years), produces an interest rate. Because these rates can change daily, you should visit the official Prosper website to see current rates. But as of the date of this article, here are grades and interest rates for each Prosper Rating:
How Lending Club Sets Interest Rates
To understand how Lending Club sets interest rates, the first step is looking at a borrower’s qualifications. Lending Club is pickier than Prosper, which is good for investors, but not always so good for borrowers. Here’s the list of borrower qualifications:
- To borrow through Lending Club, you must be a US citizen or permanent resident and at least 18 years old with a valid bank account, a valid social security number and a FICO score of at least 660.
- Borrowers will need a debt-to-income ratio (excluding mortgage) below 35%.
- In addition, your credit history must show that you are a responsible borrower:
- at least 3 years of credit history, showing no current delinquencies, recent bankruptcies (7 years), open tax liens, charge-offs or non-medical collections account in the past 12 months,
- for credit scores 740 and higher, you need to have less than 9 inquiries on your credit report in the last 6 months
- for credit scores below 740, you need to have less than 4 inquiries on your credit report in the last 6 months
- a revolving credit utilization of less than 100%, and
- more than 3 accounts in your credit report, of which more than 2 are currently open.
From all the above data, Lending Club assigns a grade to each borrower. 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. Lending Club then adds to the base rate an adjustment for risk and volatility.
Now at this point your head may be spinning. The good news for borrowers is that Lending Club can calculate all of this in an instant once it has your application, credit score, and credit history. But to give you an idea of rates as of today, here’s a snapshot of rates for grades A through D:
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. So how do you compare Lending Club and Prosper.
I’ve invested in loans on both sites for several years. I’ve generally had very good experience with both. From this experience, I’ve come to the conclusion that while both companies are good options, Lending Club has the slight edge for investors and Prosper has a slight edge for borrowers.
A big part of my conclusion is the fact that Lending Club’s standards for borrowers is higher. That protects investors, but can eliminate Lending Club has an option for a lot of borrowers.
Comparing rates between the two sites is difficult. Because they each use proprietary grading systems, you can’t simply compare one grade to the other. As a borrower, I’d look into both to see which one offered the lowest rate. As an investor, I’d use Lending Club for higher grade investments, but look to Prosper if I wanted to take on some additional risk in exchange for the chance of higher returns.
If you’d like to sign-up to be a lender or borrower, you can use the following links:
Image Credit: Wolfgang Staudt