Thursday, May 8, 2008

How I Minimize Risk on Prosper

*** This post was updated on May 10th ***

I have been a lender on Prosper for about 13 months now. Although I do not have a lot invested in prosper, I've never had a loan default or have late payments. After reading - Why Bother? from Eden at Finance and Fat, I thought it might be interesting to share my process of bidding on a loan at Prosper. When I choose to fund a loan, these are the things I do.

I initially go to the search loans box on the left side of the listings page. I do not specify a keyword and I use all loan types. Next, I specify only B or higher credit grade. 1.86% of B grade loans default and 8.89% have been late. This compares to 3.42% late on AA loans and 6% late on A loans. I leave "Include high (>20%) debt to income" checked. I also initially check to require homeownership and automatic funding.

The next step is a little fuzzy and something I'm sure financial institutions don't have the liberty of doing. I scroll through the listings and look for people that appear to be honest, good-hearted, responsible people. I also glance at the headlines and look for things that I think would be appropriate for a loan. For example (this is a real example from the search I'm doing right now), "Investments for my evil children" with a picture of a baby with red glowing eyes does not look like an appealing loan to me. From the description, "I'd like to put $2,500/yr away for each of them, but this year I can't see myself able to do so. I'd like to get a loan to get this started. Actually, I'd like NOT to get a loan to get this started, heh, but at least this way interest starts compounding now for them." If you can't see yourself as able to put away money for your childrens future, how will you see yourself able to put money away to pay me back, and to cover your interest. Not to mention that sounds like a ridiculous plan. Why pay 10.89% APR to invest in index funds that may only return 8-10%? This person has an A credit rating, but obviously is not making sound choices regarding their money. I would not fund this loan. Some titles that caught my eye were "paying off credit cards" and "investing in my family" these sound like positive goals and are things I am more likely to look in to.

Once I click on a proposed loan, I read the description. I look for things that cue me in to decide if this is not only an honest and responsible person but also someone who has a plan and knows what they are doing. In the example above, I don't think the person knew what they were doing and they had a bad plan. An example of someone with a good plan is, "This loan will be used to expand my daughter's daycare business... We have acquired a building , and my daughter has poured everything into readying this building up to city and state codes... [needs the money for the] purchase and installation of 2 commercial metal doors with panic bars, and fire protection system... I am the sole proprietor of custom cabinets. I established this company in 1988." To me, all of these things say this person is a hard worker and they know what they want and how they plan on attaining it.

Lastly, I look at the credit profile. Red flags are delinquencies, public records, high number of credit lines, high revolving credit balance, and high bankcard utilization. The first two are show stoppers. The last 3 are more of a judgment call based on the picture you've built from the other information and what an appropriate level is in your mind.

After I have found a loan I feel comfortable with, I will bid the minimum amount at a conservative interest rate. Usually I bid at 7%. To me, this is a rate I'm happy with, given the performance of savings accounts and the average 8-10% in the stock market. By bidding the minimum amount, I spread my money over multiple loans and lower my risk through diversification.

So there you have it. In closing let me just say that it is important to listen to your gut. You should be able to feel good about the loan you are purchasing. Feel free to shop around and don't be afraid to wait a little bit to find a good loan.

If you're interested in joining prosper, please use the referral link below. Lenders will receive $25 for signing up after successfully bidding on their first loan. Also, there is no hard credit check for lenders.

Business & Personal Loans. Great Rates. Prosper.


Eden Jaeger said...

Nice look at how you use Prosper. I really wouldn't mind giving it a shot with some speculative dollars, however I'm not ready to have speculative dollars until I get more debt paid off.

So have you looked at your rate of return while doing this? What is it roughly, if you don't mind sharing?

IF Blogger said...

@Eden According to the Prosper website I've earned 12.97% on average.