Peer-to-peer lending booming
When 73-year-old Bill Smith and his wife, Ginger hit simultaneous jackpots on a recent cruise-ship vacation, they knew exactly what to do with the $3,300: put it on the street. Smith had wanted to try peer-to-peer lending since reading “At Last, a Bank of Your Own” in Barron’s in January of 2008.
“I told myself that if I ever get some unexpected gift money or a tax refund, I’d give it a try,” says the Florida retiree. “Upon returning home from the cruise, I made my first Prosper (www.prosper.com) loan for $50.” Prosper is a loan-auction site.
Smith’s portfolio now includes $9,342 worth of Prosper loans and $16,864 facilitated through the rival site Lending Club (www.lendingclub.com). He immediately reinvests about $300 a week in repayments, getting up at 5 a.m. to get an early shot at new-borrower requests. After the 1% loan-servicing fee and a similar percentage lost to defaults, Smith says he’s realizes an average net interest rate of 12.27% on his combined portfolio: “For a retiree, it’s comforting to see your cash doubling every six years.”
IT’S NO SECRET BANKS HAVE become tight-fisted. But creditworthy borrowers (and not-so-creditworthy) haven’t gone away. Financial researcher Celent (www.celent.com) figures online borrowing will double next year, to almost $6 billion, with Prosper’s membership topping 1 million. Other variations on the person-to-person, or P2P, theme include Loanio (www.loanio.com), Pertuity Direct (www.pertuitydirect.com), Virgin Money USA (www.virginmoneyus.com) and England’s Zopa (http://us.zopa.com).
The average loan size crossing such channels is about $5,000 now, down from about $6,000 last year, according to industry experts. P2P sites temporarily stopped taking funds from U.S. investors last fall, when the Securities and Exchange Commission questioned how these new transactions should be regulated.
The SEC now considers them sales of securities, and it shares oversight of the Websites with state regulators. The sites therefore must get clearance to operate from state governments, about half of which have given approval to lend so far (only a few states still prohibit P2P borrowing).
Prosper, Lending Club and recent startup Pertuity Direct have begun accepting U.S. money again. Other sites are lending overseas, while nibbling at the U.S. market indirectly. For example, Zopa is acting as an intermediary between U.S. borrowers and credit unions. Borrowers get three-year loans at fixed rates of 8% to 29%, which have yielded average returns for lenders of 8% to 9% lately, less a 1% service fee and defaults. After a rocky start in which his high-interest returns were decimated by defaults, Smith quickly learned about creditworthiness. Some 1,800 loans later, a variety of strategies and tactics keep his defaults at around 1%.
For example, Smith stays away from borrowers whose principal motivation is relief from a single, high-interest-rate credit card — a common motivation for borrowers. But a full third of his portfolio goes to borrowers trying to clear away all their debt.
Smith won’t lend you money for a wedding ring, but he’ll be happy to underwrite a wedding or new baby. “So many engagements are called off,” reasons the retired florist, “but weddings are a show of force and are somewhat collateralized by gifts of money.” People are anxious to forget a broken engagement, but pay back loans that underwrite happy memories.
Smith also won’t lend on new cars, but will help you purchase a used car, scooter or other basic transportation to downsize your lifestyle. He’ll finance dental work or renters saving for a down payment on a house, but not someone struggling with a mortgage, nor college students.
Prosper lender Ken Miller, on the other hand, says he has realized an average interest rate north of 15% by focusing on students, a market in which sites like Fynanz (www.fynanz.com) and GreenNote (www.greennote.com) specialize.
The professional poker player feels that students’ limited credit histories push young people into lower-credit grades with lending premiums that don’t necessarily represent the risk involved (www.prosper.com/invest/how-to-invest/prosper-ratings). Miller says he gains “an information edge” by directly contacting borrowers to verify their bona fides. At a time when credit-default rates at the nation’s largest banks have reached double-digits, Miller has no defaults in his 60-loan portfolio.
Software engineer Mike Fisher improves his chances of getting paid back by lending to fellow Microsoft employees. He’s the leader of the 88-member Microsoft Employee Group, which, to date, has had no defaults — even though Fisher reaches down the rating scale to help those who have “struggled” with credit in the past. He’s content to post aggressive Prosper loan bids whose average interest rates net out to about 10%.
SAN FRANCISCO COMPUTER PROGRAMMER David Pon relies heavily on direction from a group leader and fellow lenders. Touting the wisdom of the P2P crowd (www.randomhouse.com/features/wisdomofcrowds), he lends partially for philanthropic reasons to Third World microbusinesses through international sites like Kiva.org and MicroPlace (www.microplace.com). After 264 total loans and a rather high default rate of 12.5%, Pon has managed to eke out a net return of almost 5%.
Detailed performance metrics for individual Prosper lenders are available on Eric’s Credit Community (www.ericscc.com). Eric’s also keeps voluminous statistics on the performance of the P2P community at large.
While Prosper’s loan rates are set by eBay-style competitive bidding, Lending Club fits borrowers into a 35-tier grading matrix (www.lendingclub.com/info/how-we-set-interest-rates.action). Since relaunching, Prosper has stiffened its credit requirements to trim its historically high average default rate to around 5%. Its collections and credit requirements are now closer to those of Lending Club, where the average default rate is around 3% and only one in 10 borrowers qualify.
P2P lending isn’t a set-it-and-forget-it investment, says Roy Henry, a retired registered financial consultant who manages a $20,000 Lending Club portfolio that he says has a net return north of 13%. Lenders must actively manage their portfolios, which should take about a half an hour a week after orientation.
But it’s a niche no longer being aggressively chased by banks, says the St. Louis resident: “And where else do you even have a shot at these kind of returns?”