I have been lending in peer-to-peer lending networks like Lending Club and Prosper for a few years now. I believe that peer-to-peer lending networks are gaining credibility; especially with the successful Lending Club SEC registration in 2008. In 2008, I made +8.73% with Lending Club and + 7.58% with Prosper, which was decent returns considering the economic condition.
To start lending with Lending Club:
That’s it. For a first time lender, I suggest using the LendingMatch tool to invest $25 in a loan in the lowest risk category. The process for Prosper is just as easy, so I won’t be covering it here.
In case you’re not familiar with peer-to-peer lending, these networks bring together a large number of lenders and borrowers. As a lender, you have the option of lending as little as $25 to a borrower. If you have a large sum of money to invest, you can spread it out over multiple borrowers (or loans) or you can invest more money in each loan (not recommended). As a borrower, you can borrow as much as $35,000 and this amount can come from one lender (unlikely) or multiple lenders.
Here’s a nice image from Lending Club’s How Social Lending Works page.
However, I must warn you that peer-to-peer lending is not without risks. When I started, I was enticed by the higher interest rates on higher risk loans (i.e., borrowers have poor credit ratings). This worked out fine initially, but I am starting to see late loans and defaults.
For example, I had two defaults in my Lending Club account that amount to $45.38, which effectively wiped out my gain resulting in a -1.88% loss in 2008. I fared slightly better with Prosper, where I had three late loans, but no default.
Except for one loan, all of these late and default loans are subprime rated loans. So my advice is: Stick to prime rated loans, if you want to start investing in peer-to-peer lending networks. Lending to borrowers with good credit will not eliminate credit risk, but it will great reduce that chance of losing your money due to defaults.
Reviewed and updated on March 20, 2011.