Lending Club and Prosper Rate Differential: Opportunity or Not?

By Pinyo, on January 14, 2008

In my post, “My Foray into Prosper as a P2P Lender,” one of my readers (PeerLend.com) introduced me to Lending Club:

“In early December [2007], Lending Club opened their (formerly FaceBook users only) lending application to the wider public. They do things a bit differently than Prosper, as they underwrite the loans (i.e., bucket by credit grade and set interest rates for each bucket). They have a 640 FICO minimum for borrowers, as well as a max. 30% DTI, so maybe a better pool of borrowers. Plus they have a $25 minimum bid, which means you can diversify into twice the number of loans as with Prosper’s $50 minimum.”

Since then, I’ve signed up with Lending Club to have a look around. I haven’t start lending yet, because I still want to focus on Prosper and learn more about the implications and risks of investing in this space. Basically, I am taking it slow. Anyway, one thing I did notice right away is the rate differential between the two peer-to-peer lending sites. At the first glance, Lending Club has better rates for borrowers, and Prosper has better rates for lenders (data from PeerLend.com as of 1/2/2008).

Both sites break down their credit rating structure into seven credit grades, and these are the average interest rates (data as of 1/2/2008):

I know that there are people with good credit ratings on Prosper who borrow to reinvest in Prosper. So this is really interesting because there seems to be an opportunity here for savvy investor to borrow from Lending Club, lend to Prosper, and make money off the difference. Or, is there? After further investigation, it appears that these seven credit ratings are not created equal; specifically, Lending Club doesn’t go as deep into the high-risk sub-prime territory as Prosper does. Moreover, it appears that the idea of borrow-to-reinvest within these peer-to-peer networks is not as practical as it first appears to be. For example, there is a good article, “Borrowing money to lend on Prosper: Wise or Foolish?” on Prosper Lending Review about this topic.

Why am I telling you all this?

• Due Diligence – This is one of those too good to be true scenario. But after some investigative work, it wasn’t hard to see that the opportunity really isn’t there.
• Efficient Market Hypothesis — Although P2P lending is minuscule compared to the stock market, I do believe that there are enough people in the P2P space to make this kind of opportunity improbable. For instance, if this opportunity is real…
  • There will be more borrowers at Lendng Club. This will push the interest rate up as more people compete to borrow.
  • There will be more lenders at Prosper. This will push the interest rate down as more people compete to lend.
  • The net effect is therefore a smaller spread, making this type of opportunity unprofitable.
• Don’t Rush – It’s easy to get enamored with something new. Just like any other investments, there are inherent risks that may not be very obvious. This is why I am only investing a small amount in peer-to-peer lending.

If you want to try out peer-to-peer lending, please do — it’s good to experiment and find new ways to grow your money. Beside, you can get $25 sign up bonus by using either one of these links: Lending Club and Prosper. This makes your first loan on Lending Club virtually risk-free. However, just be cautious. If the sub-prime debacle could burn multi-million dollar companies with hoard of MBAs, it could burn you also.

More about peer-to-peer lending:

• Get Rid Of Your Debt With These Debt Defying Strategies @ The Digerati Life
• Revealing the Keys to Prosper Success @ Lazy Man and Money
• What is Peer to Peer Lending? @ Money Smart Life
• Number of borrowers on Lending Club increase @ Prosper Lending Review
• The Market Versus The Experts @ Prosper Blog

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Pinyo is the brain behind Moolanomy personal finance blog and a few other web sites. If you like this article, please subscribe for free daily email updates.

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