Introduction to Peer-to-Peer Lending

I have been lending in peer-to-peer lending networks like Lending Club and Prosper for a year now. I believe that peer-to-peer lending networks are gaining credibility; especially with the successful Lending Club SEC registration in 2008. Last year, I made +8.73% with Lending Club and + 7.58% with Prosper, which is decent returns considering the economic condition.

How To Start Investing In Peer-to-Peer Lending Networks

Since Prosper is going through a SEC filing process and is not currently accepting new lenders, I will use Lending Club as an example. To start lending with Lending Club:

Go to Lending Club web site
Click on Try It Now button
Complete the application
Click on the confirm link in the registration email, and log in
Click on the Invest button
Complete your profile (4 steps long) to verify your identity and link your bank account to Lending Club
Once verified, click on Add Funds from My Account tab, and transfer at least $25 to your Lending Club account
From My Account tab, click on Invest to start lending money

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.

How Peer-to-Peer Lending Works

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 $25,000 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.

A Caution About Peer-to-Peer Lending — Don’t Get Greedy

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.

In particular, there are currently two defaults in my Lending Club account that amount to $45.38. This effectively wiped out my gain resulting in a -1.88% loss for the year — luckily, I am faring better with Prosper. I also have three loans that are late. However, I am confident that investing in loans with higher credit ratings will result in handsome profit in 2009.

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.

19 Comments

Sam
January 6, 2009, 21:28

How much have you deposited into these? I put in 2k and have stopped adding more since I got a few defaults. I never calculated my return. Sounds like you did really well. Maybe I will re-evaluate mine later.
Brett
January 6, 2009, 22:27

I agree with you that you need to stick to the higher credit grades. I prefer to lend on loans of lower total value. Also, I recommend new lenders learn what the different fields mean to help you evaluate the credit information. Don’t just learn that inquiries means that the person pulled credit to be evaluated for a loan, but that a high number of credit inquiries may mean they person is loading up on debt, other lenders are denying loans to the person, or it might mean desperation for money.
Several bloggers gave me some more p2p lending advice when I first started lending.
Odnal
January 7, 2009, 8:11

My experience with Prosper has not been so positive. I invested about $1800 between 34 loans about a year and a half ago. Of those, 7 have defaulted and 1 is 4 months late (effectively defaulted). I’ve invested mostly in A, AA, and B loans, which according to lendingstats net me negative 3.62%
Lending Club has been a little bit better. I believe they have higher credit score requirements to begin with. I had $2875 invested in 87 loans. Those are about a year old and only two have defaulted so far, so I think my return is positive there, but have never calculated it. I was also fortunate to have earned a free $268.75 on lending club, which has helped to balance out the losses at Prosper .
Pinyo
January 7, 2009, 8:43

@Sam – I only have about $1,200 invested in the two networks. I am only adding what I can afford to lose.
@Brett – Good point about borrowers with lower loan value. My defaults are also higher value ones.
Dawn
January 7, 2009, 13:21

I’ve done quite well with Prosper. I am hoping to be able to reinvest in them once their SEC filing is done. I have 3 loans, all are current.
Chiko
January 9, 2009, 14:56

I think I am going to add this to my building wealth activity. I think I like lending club better though.
AlRitch
January 11, 2009, 14:22

This is interesting as I’ve based it on the comments made by others and your post. I guess I will also be applying for this. I just hope my investment will be of the same as you.
Dan
January 12, 2009, 16:33

I used Prosper.com for a while in 2007, 2008. It was going well until we entered an unprecedented recession! I’m still at a slight positive at .35% estimated ROI through lendingstats. I guess in hindsight, much better than a 40% wallop in the market. Any thoughts on differences/benefits over Prosper?
Curt
January 19, 2009, 23:50

I think the recession is about to kill the market. As the recession deepens, the defaults will increase – just like they are with credit cards. Cash out while you can.
The Almost Millionaire
January 22, 2009, 18:58

I’ve got friends who are averaging over 10% with P TO P lending, but you are absolutly correct, there is risk and there is fraud out there. Great advice to go in to it with your eyes open.
Atlantic Bodyboarding Shop
January 26, 2009, 1:16

Interesting, I never knew there was such a service, will have to check it out. Thanks
Bernz
February 1, 2009, 20:54

I have been a Prosper member for over a year now but never really did get into the business of lending money. I signed up with the purpose of becoming a lender to received a better return for my money but just could not pull the trigger just yet. Have heard both positive and negative results but lately have been inclined to really going for it now as there seems to be no place out there where your money can actually make a decent return without any risk involved anyway.
Pinyo
February 3, 2009, 20:05

@Dawn – I can’t wait for Prosper to reopen to lenders. Competition is good for consumers.
@Chiko and AlRitch – Give it a try. But just like any other investments, make sure you understand the risks so that you can properly decide. I am planning to write about default risk when making person to person loans — hopefully, some time later this week.
@Dan – Prosper and Lending Club should be compared to bonds as opposed to stocks. And they are probably more like junk bonds than anything else.
@Curt – Default risk is definitely a concern and I am planning to explain the issue to my readers. But remember, every investment comes with its own set of risks.
@Bernz – May be you want to wait for my default risk article before making your next move.
Bernz
February 4, 2009, 13:37

Okay, I will definitely wait for that default risk article before doing anything.
BLD
February 8, 2009, 13:10

techically isn’t a default on a loan is an investment loss to the lender?
and if so, can this be recovered through tax forms?
Pinyo
February 8, 2009, 13:15

@BLD – Yes, default would be considered an investment loss that can be deducted for tax purpose. The caution for new person to person lenders is never to take the interest rate at the face value because defaults can lower the overall performance or even put you in the negative.
Bob
February 10, 2009, 10:34

LOL what a waste of time at these rates, you are giving your money away. You are lending out money to unsecured borrowers at rates reserved for prime and known borrowers. Your local bank would never lend below 9% (best rates) for a personal loan to the most credit worthy borrowers, why are you lending at rates below that?
You’re chasing 3-4% above CD rates and adding so much risk. You’re better off buying high yielding stocks who won’t cut their dividend, a Verizon for example paying 6%.
My Journey
February 25, 2009, 12:34

Bob there are NO stocks that might not cut their dividend…J.P. Morgan cut their dividend from 38 cents to 5 cents for the first time in 30 years. I think one point Pinyo missed (I am sure he covered it in another review) is that the venture into p2p lending is not correlated to the market.
Chiko
May 22, 2009, 7:52

I tried to sign up, but I guess you can’t use it if you live in Maryland? Can anyone help me out, cause I really want to sign up to LengingClub