Micro Lending: Prosper.com

This is an account of the experience that I have had with a fairly new concept in lending. When you borrow money, you usually borrow it from a major financial institution. Why? Well, for myself, the process of borrowing from a large bank puts distance between myself and the bank and as a result, I don’t feel as though I am personally in debt to someone I know, which is odd, since business is a very personal experience, or should be.The Concept

How do you feel about lending $100.00 to a friend? I would submit you don’t consider it a favorable venture if you’re looking to invest. There’s usually no return. I would prefer giving a friend in need the money outright. Something about demanding an interest rate on a $100.00 loan to a friend just doesn’t jive. What kind of friend would you be to expect interest on such a small loan, and to a friend at that?

What do you do then, if you have $1000.00 sitting in your bank account earning a measly two percent (2%) annually and you wish to improve your return? The answer can be found on micro-lending websites such as Prosper.com, a rather new lending website where lenders bid on borrower’s listings much like consumers on eBay auctions and you become the bank.

How does it work?

With a minimum bid of $50.00, a potential lender can invest in a borrower at a given rate. The borrower pays back the $50.00 loan over a 36 month term. Here’s an example. Joe Borrower has a $10,000.00 credit card balance with a high 18.99% annual rate. If Joe wants to pay off his credit card within 3 years, he’ll need to pay out $457.00/month to meet that goal. Instead, Joe seeks out funding at Prosper.com. He pleads his case with the community of lenders and offers a lower rate, perhaps 12.00%, saving him 6.99% annually.

Based on today’s rates of return on bank investment accounts, 12.00% is a fantastic rate. Would you be willing to lend Joe $50.00 at 12%? I would, provided I was given enough information about Joe and his finances. But Joe needs $10,000.00 and I’m not going to put all of my money in one borrower. So, I come to the table with $1000.00, but only bid $50.00 towards Joe. The rest of the money is bid towards other potential borrowers at various rates. Joe needs 200 people each bidding $50.00 minimum to fund his $10,000.00 requirement. Since Joe looks like a solid bet, it’s possible that he may receive more bids after his loan requirement has been met. If this is the case, the rate decreases upon subsequent bids, knocking the highest rate bids off the bottom of the lenders list and so on, until the listing ends. Upon the close of the borrower’s listing, he or she is funded and begins a 36 month repayment period.

Payments are sent to Prosper, and prosper distributes the funds accordingly to all lenders involved. Each month, every lender receives a small payment consisting of both principal and interest. When the lender’s principal repaid reaches $50.00, another automated bid, based on the lender’s criteria, can be placed and the process can continue; a sort of re-investment plan.

If you choose not to re-invest you will recover your investment over a 3 year period, unless the borrower pays off the loan in full prior to maturation date, otherwise, your initial investment will continue to grow.

How is it working for me?

If you really want to see how it’s working, the information is publicly available at www.lendingstats.com under my lending name of Liquid. Well, I started in October of 2006 with $1000.00. I immediately bid upon 20 different loans at $50.00 each. It took 3 weeks to verify my bank account and make the initial transfer so I would have funds in my Prosper account, and once the money was there, the bidding process took another 2 weeks to complete before all of my $1000.00 was invested and earning a return.

At this point, it became a waiting game. I setup an automated bid so my principal repaid would automatically re-invest itself in new loans. It is now December of 2007, 14 months after my initial venture. I started with 20 active loans at $50.00 each and now have 24 loans worth $1250.00.

This would appear to be a great return of 17% annually, but that’s not exactly true because two of the loans defaulted, a fairly steep drop in return from 17% to roughly 6%, outrunning inflation, but not by much. One interesting piece of information about this is that I spent nearly zero time on managing the investments. I simply set my criteria and let the system automatically invest for me. Had I diligently searched through listings and bid with more scrutiny, I may have dramatically increased my return. After all, 6% isn’t that great, but at least it isn’t 2%.