Prosper.com - The future of lending?

If you haven’t heard of Prosper.com yet, you may hear about it very soon. The company was started by E-Loan cofounder Chris Larsen and, according to their website, they have 140,000 members and have funded $27,000,000 in loans in the past year. Their platform allows individual borrowers and lenders to come together to meet each others needs.

As a borrower, you can post a request for a loan. You specify your acceptable interest rate, amount you want to borrow, and as much information as you want to expose to the public about why you need the money. Prosper.com runs a credit report on you, verifies your identity, then displays your credit rating on a AA, A, B, C, D, E, HR (High Risk), and NC (No Credit Score) scale, your debt to income ratio, and your post for the world to see.

Borrowers can request unsecured loans up to $25,000.

Lenders can come to Prosper.com and fund any loans that they wish to. Lender’s don’t work with the borrower directly (though the lender can contact them through email), instead, Prosper.com funds the loan and sells the loan to the lender.

All loans are over a three year term and, if the borrower is late on a payment or defaults on the loan, Prosper.com does its best to right the situation. In late payment scenarios, Prosper.com attempts to contact the borrower. If the payment is over 15 days late, they are assessed a late fee depending upon the borrower’s state law. If payment is over 30 days late, the loan is sent to a collections agency and all of the collections work is handled by Prosper.com. If the loan goes unpaid after 3 months, it is written off and sold to a debt buyer.

Fortunately, Prosper.com has taken two steps to mitigate risk, at least to some extent, for the lender. First, borrowers can belong to groups. A group can be formed by anyone, but can serve as a reference if you will for the borrower. Groups themselves have their own ratings of reliability. If folks within that group default, that group’s rating suffers, and lenders may be less likely to loan to members of that group going forward. This group concept seems slightly handy, but given that it is voluntary and that the group leader profits from forming a group, I can see the tendency for groups to come and go and for there to be an attempt by group leaders to make a quick buck and move on. Secondly, Prosper.com allows borrowers to fulfill only part of a loan. For example, if you visit the site, you’ll see there are many loans for 5, 10, 20 thousand dollars, and unlikely amount for someone to lend when they don’t know who is doing the borrowing. Prosper.com’s platform allows you to specify any amount from $50 up to $25000 to fund per loan. They do this so more folks can participate in the lending process, and lenders can distribute their risk over many smaller loans. Prosper has some slick tools to allow you to auto diversify if you want to, or you can pick and choose which loans you want to fund and for how much. Borrowers will often fund their loans via many different lenders and lenders will often diversify their loans across many different borrowers. That is a great idea, though it seems it could get messy if Prosper’s tools to track loans, borrowing, defaults is not top-notch or suffers from quality problems in the future.

So, the real question is, is it worth it? Well, scanning the front page of loans at the moment, I see borrowers requesting loans for $18,000 @ 24% interest (credit grade: D), $15,000 @ 11% interest (credit grade: AA), and $8,500 @ 16.5% interest (credit grade: C). If you have a chunk of cash that is sitting in a low yield savings account and you are open to taking on additional risk, those are pretty darn attractive rates. Prosper.com lists default rates and loan figures on its “Marketplace Performance” page, where you can see default rates among each of the credit classes.

I have a couple concerns with Prosper.com:

1) Credibility of the borrowers: Every loan request has a quick blurb attached about why they need the money, often they attach a picture, but I see no way for Prosper.com to verify that information. It really all comes down to the credit grade and the debt to income ratio. Someone can post a touching request about needing money to fund their mother’s surgery or something, but if there is no way to verify that, you really cannot rely on that.

2) Ease of use and informality: You are lending money to people you don’t know everyone! You have no way to verify what they will spend the money on and you have no way to see their credit report details firsthand. Banks can’t easily verify what people spend money on either, but they have more tools at their disposal for verification purposes. If I’m going to lend money to someone who I’ve never met, I would like to be able to see their credit report firsthand. I can look at a debt to income ratio and say “that seems reasonable”, but if the debt is student loans that they’ve been paying on for 5 years already vs. debt that is revolving on 6 different department store credit cards, those are very different situations.

3) Liquidity: The loans are all based on a 3 year term. According to the Prosper.com website, there is no way to sell loans to others if you want to get out of the loan early, though they “hope to allow lenders to sell their already-owned loans to other lenders in the future”. I can see a lot of folks may get excited about lending out their money at 15% right now and jump on it, but they apparently have no way to back out (even at a loss) if they need to get their capital back within the three year window (unless the borrower pays off their loan early, which is their option). This is one main difference I see between Prosper.com lenders and a standard financial institution. A bank can create immediate liquidity in many of it’s investments by selling their loan portfolios to other institutions. With Prosper.com, you’re locked into a 3 year loan. I haven’t found the answer to this question yet, but it seems important..What if your borrower’s credit score drops significantly within the course of the loan? What is your recourse to get your money out?

Overall, Prosper.com seems like a very exciting opportunity for both buyers and sellers. Even if their platform has a few weaknesses, the concept seems excellent. I could see this concept put to use in a more widespread fashion in the future with loan servicing agencies buying loan portfolios from large institutions at a discount, then turning around and selling those loans to consumer “lenders” at the market rate, with the loan servicing agency yielding a profit on the sale of the loan and income from ongoing servicing fees. They can reduce their risk to almost zero while maintaining a relatively guaranteed income stream over the future. Prosper charges a 1% “closing” fee of each loan to the borrower (minimum: $25) and a 0.5% annual loan servicing fee to the lender. If a loan goes into default, the lender is responsible for paying the collection agency fees which, according to their website, are “typically between 15 and 30% of the funds recovered”.

For more information on Prosper.com, visit the following websites:

• Prosper.com - contains tutorials of borrowing/lending process as well as all the fine print
• BusinessWeek article on the company
• New York Times article on the company