Is Peer to-Peer Lending Ready for Prime Time?
By Pinyo • Feb 11th, 2008 • Category: Credit and DebtIt has been a while since I wrote about my peer-to-peer lending investments. DebtKid recently interviewed me, and you can see our interview on Lending Club. One of the questions the stuck with me was: “Do you think P2P investments should fit into an investor’s portfolio?”
Peer to-Peer Lending Is Not Ready for Prime Time
In my response, I indicated no. I think it’s certainly feasible but I don’t think we are there yet. Personally, I still consider this investment riskier than the stock market and I would invest money that I could afford to lose. Here’s why.
Stability of the Establishments
The stock market and my brokerage firm (who is holding my money) are established entities. I can go to bed at night and feel comfortable that when I wake up the stock market will open and my brokerage firm will still be in business. I still don’t get that feeling with Prosper and Lending Club yet. I would like to see these online networks become more established as business entities.
I am aware that my money is committed for 3 years when I lend it out. I understand there is no guarantee that I would get my money back if my borrowers default. However, I can manage this risk by lending to borrowers with high credit rating and good Debt-To-Income Ratio (DTI). I can’t control the stability of these two networks. I want some kinds of guarantee that Prosper and Lending Club can’t simply shut down one day and walk away.
Investment Liquidity
When I invest in the stock market, I can liquidate my investment at any time. With peer-to-peer lending, each contract last for 3 years. I cannot sell the loan to other lenders or to the network itself. For P2P lending to make it as a prime time investment vehicle, I think there should be a way for lenders to terminate their contracts early either by selling them back to the network or to other lenders. Without this ability, P2P investment is not as attractive as it could be.
But Peer to-Peer Lending Is Promising
Although it’s not ready for prime time, I think it’s a relatively good investment that pays better than online savings or CDs. Moreover, it works well as an alternative income opportunity. For instance:
- Prosper offers each new lender a $25 bonus after making the first loan — so that’s free money for new lenders. Also, existing members can refer a new lender for a $25 referral bonus, or a new borrower for a $35 referral bonus.
- Lending Club similarly offers $25 to new lenders and $25 for referral; however, the bonus is paid as soon as the new account is verified — no lending is needed. Essentially, you could sign up through this link to get $25 for signing up, and your spouse could sign up using your referral link. As a result, each of you will get $25 more, for a total of $75. That’s free money!
Learning More About Peer to-Peer Lending
Over the last few weeks, I have seen many good articles on peer-to-peer lending and would like to recommend a few:
- From my own blog My Foray into Prosper as a P2P Lender and My Second P2P Loan On Prosper
- From Cash Money Life: Is Person to Person Lending Safe? and Prosper - the Ebay of Person to Person Lending
- From The Dough Roller: A Visual Guide to Lending Money with Prosper’s New Portfolio Plans and How I Overcame My Fear of Lending Money on Prosper.com
- From Rocket Finance: My foray into peer to peer lending
- From Money Smart Life: What is Peer to Peer Lending?
This post was featured in:
- The Carnival of Peer-to-Peer Lending #4 hosted by Prosper Lending Review. For more information please visit the Carnival of Peer-to-Peer Lending.
All posts by Pinyo
thanks for the link.
Making it possible to sell the actual loans is an interesting idea. It could get complicated, but someone who owns a loan at 12% might be interested in selling the loan for 4% or 5% up front. An idea like this might actually make Prosper and Lending Club more stable for the long term.
I am regularly investing in Lending Club, but only small amounts right now. The $50 bonus makes it a whole lot easier to swallow.
I would love the ability to sell existing loans. The biggest drawback that I see in P2P lending is that your money is tied up for the entire length of the loan. With almost any other type of investment, you may have limitations or fees, but can usually get your money out at any time. But with both Prosper and LendingClub, you don’t have any options for liquidating your loans.
Prosper briefly mentions here, that it ‘hopes’ to have the ability to sell loans in the future, but it doesn’t sound like it is too high on their priority list.
Pinyo, that’s a great point. The liquidity is the biggest downfall that I see with P2P lending. The ability to sell or otherwise transfer loans would make P2P lending a better investment option for many people. I only have a few hundred dollars in there, and it is money that I don’t need any time soon. Great article, and thanks for hte mentions.
Of course, an open market for loans opens up the whole system to insider trading i.e. telling your friends to sell your loan just before you declare bankruptcy. It sounds like a legal nightmare to me, though I agree, it’d certainly be nice to have a LITTLE liquidity built into the system.
I too am just dabbling in P2P lending. To me it’s similar to junk bonds where there’s likely to be wild swings in the number of delinquencies based on the overall economy, but along with the high risk (and illiquidity) comes a higher return. Going over lendingstats.com, it seems like 6-7% returns are pretty easy to achieve when focusing on A and AA borrowers, and while higher returns are possible by picking the best loans that fall into riskier portfolio categories, my level of expertise leads me to stick to the most conservative strategy.
When I read the original post, I emailed a contact at Prosper about a timeline for reselling loans. His response included:
“Our secondary market is a priority right now but we have no timeline yet as we are awaiting more approvals.”
I agree that it opens up a lot of possibility for fraud and loopholes though. It is still a very new investment product, and it will be interesting to see how it matures.
I think those are all great observations. P2P lending really seems like it’s coming along but it’s still got a way to go. I wonder who’s in charge of developing that sort of thing with Prosper and Lending Club. They should really see these.
I’m personally not ready to consider P2P lending. I’m still getting out of debt. I liked looking into this idea for the future. Perhaps then, I’ll consider for some investments
I think it really depends on the individual and the level of risk/reward that they’re comfortable with. It’s definitely not for everyone but I think it has potential if used correctly and I imagine we’ll see many more developments in the industry in the months & years to come. Oh yeah, and thanks for the mention!
@Deamiter - Interesting point about fraud. Now this lead to the question: Is peer-to-peer lending well regulated?
Right now I am lending at about 10-11% on both network to prime rated borrowers. I’ll be happy with this ROI and won’t push my luck with lower credit grades.
@Odnal - I am sure both LendingClub.com and Prosper are working on this. I think this is a tremendous marketplace advantage for whoever comes out with it first.
@Laura - I agree. Get out of debt first. Even then, you’re better off investing in the stock market until you have a little extra money left over to play with P2P.
@Ben - Good point and you’re welcome
Pinyo, thanks for posting your thoughts on the space. Lending Club has addressed one of your concerns (”I can’t control the stability of these two networks. I want some kinds of guarantee that Prosper and LendingClub.com can’t simply shut down one day and walk away.”)
This is from the FAQ at http://www.lendingclub.com/info/faq.action#g9
“What happens if Lending Club goes out of business?
In order to make our members comfortable, we will use a backup servicing relationship whereby our agent would service all outstanding loans including collecting monthly loan payments from borrowers, distributing funds to lenders, handling collections and credit bureau reporting, as well as providing necessary loan documentation.”
Patrick from Lending Club
@Patrick - thank you for sharing that information with us. So, it sounds like I am “insured” against loss in case LC goes belly up. Is there a limit? For example, FDIC insurance limit is only $100,000.
@Pinyo - thanks for the reply, but not exactly. We offer FDIC pass-through insurance to all unlent funds in lender accounts, but once the funds are lent, they are not insured by us, the FDIC, or any other entity. FDIC pass-through insurance is good for up to $100,000 per lender.
This is not insurance as much as it is a business continuity plan: should we go out of business (and let’s hope that does NOT happen!), we will use a backup servicing relationship whereby our agent would service all outstanding loans. No new loans would be originated, but existing loan portfolios would continue to be serviced by that servicing agent.
Patrick from Lending Club
Prosper has a similar policy: From the FAQ
What if Prosper were to go out of business?
In short, no new loans would be created, all lender funds not actively associated with a loan would be returned to the individual lenders immediately, and all existing loans will be serviced to completion by a third party loan servicing agent.
If Prosper were to go out of business, the third party loan servicing agent would take over the administrative responsibilities such as the transfer of monthly loan payments, providing timely payment notices, monthly lender statements and required tax documentation, overseeing the collection of delinquent loans on behalf of the lender, and reporting payment performance to credit bureaus.
Borrowers of course are still obligated to make payments on their loan. Prosper’s existence (or lack thereof) does not change that obligation legally or otherwise, and failure to meet those obligations would result in the same consequences for the borrower.
As a possible alternative, you might also take a look at Zopa.com which is more of a CD with a slight P2P twist than an actual P2P site. Funds lent on their site are guaranteed by a credit union somehow, and are even guaranteed against lenders who default. But their rate reflects the low risk - they are currently advertising only 4.25% APY
I’m tried of bloggers pimping themselves to the P2P lenders for profit. Thanks for being fair in your assessment. The defaults are too high, fees are too high, and profits are too low. I’ll check back in a few years to see if there is improvement, but for now it’s a bad investment.
On another note, I can’t wait until we can resell the loans! I’ll package them up into CDO’s and hide all of the risk! I’m become a million errr BILLIONAIRE selling the toxic loans. Oh wait, the big banks already did that with mortgages. I wonder if anyone learned their lesson. I bet not
While I have heard much about these in the blogosphere, I’m not into these yet. Great read. Nice use of keywords in your title.
@Patrick - Thank you. Now I understand it better. So when will you offer loans buyback?
@Deamiter - Thank you. I should have read the FAQ more carefully. It’s good that this is sorted out. I will have to do some type of clarification post in the future.
@Odnal - I haven’t looked at Zopa.com yet. Sounds like a good alternative to CD.
@Adfecto - I am not advocate one thing or another, but I do have a small amount invested. Although, it’s way early to tell if the is a good, or bad investment.
With the $25 bonus, it doesn’t hurt to give it a try.
@PT - I guess you are referring to “Prime Time”
The way I look at this is two seperate investment vehicles, the stock market as an investment portfolio and P2P lending as a lending portfolio. This allowed me to keep my thoughts separate instead of combining them as one and the same because P2P lending is really a debt instrument.
Part of the reason I am approaching this as a seperate portfolio is because it is similar to an IOU which is a type of asset found in the asset column of everyone’s net worth.
I admit I am still not quite sure how to view stock and bond instruments yet because they still do invest in debt one way or the other.
@Mark - From that perspective, you’re correct. At the same time, there are bond funds where I can invest in bond with good flexibility.
How about that…mutual funds for P2P lending.
If you are concerned about your money’s safety, yet want to help others, may I suggestion Zopa.com or Kiva.org? Both are fantastic options to get your toe dipped in the P2P waters without all the loss of sleep one can encounter. I lend through Prosper.com and LendingClub.com and find they are definitely catering to different cross-sections of people. Prosper.com involves more risky people and still bloated from a glut of sub-prime lending from 2006-2007 before they changed the credit breakouts so lenders could start to see the mistakes of lending to riskier people and the costs associated with such a gamble. LendingClub.com has kept itself on the high-end prime credit market which should mean fewer disasters to ones portfolio at a slight hit to possible returns (12% still isn’t too shabby though). Zopa.com offers good CD returns, but has a restrictive minimum entry cost ($500). Whereas Kiva.org is a zero interest, but huge human dividend P2P that has a good track record and is the only one that is global and true P2P on that front (MicroPlace.com isn’t true P2P as you cannot select your borrowers specifically). I keep a diversified P2P portfolio myself, but to each their own.:)
My two cents + interest.
Concerns about stability are valid. But the fact is, stability doesn’t occur without longevity and logevity doesn’t occur without being around for sometime and being around for sometime won’t happen without starting somewhere and simply going on. The point is that shifts are occuring in the way services are being delivered, not only in advertising but also in traditionally conservative callings like banking. That’s the future staring us right in the face.
Have you seen peer to peer insurance at http://www.peertopeerinsurance.com?
This proves that even the way people are going to be covered and protected for emergencies is going to be social in nature, what with all the unforseen power handed down to the average person by this great constellation called the world wide web.
Bottomline? Trailblazers will have to be given a chance and they, in turn, will have to protect the public trust. Who says the relationship between the service merchant and the consumer has always been that open-and-close easy, even in history?