Peer to peer lending sites, such as Prosper and Lending Club, facilitate the lending of money by investors to other consumers who are looking to borrow money. Read on for my Prosper & Lending Club reviews.
Prosper & Lending Club Reviews
Peer to peer lending can greatly benefit both investors and borrowers. For investors, it adds additional diversification to their investment portfolio and provides the opportunity to earn higher returns on their money than through many other common investment alternatives.
Peer to peer lending companies offer many borrowers the opportunity to borrow money at lower rates than what they could at a traditional bank, making it an attractive deal to them as well.
This article focuses on investing in peer to peer loans (peer to peer lending). I’ve discussed taking out a peer to peer loan (P2P borrowing) in another article.
Investing in Peer to Peer Loans
Peer to peer lending investors have received average annual returns of about 10% since 2009. That is quite impressive. As with any investment, it is important to understand both the pros and cons of investing in peer to peer loans, including the risks involved.
Benefits of Investing in Peer to Peer Loans
High Potential Returns
Investing in peer to peer loans has the potential for earning very high returns, even in a rock bottom interest rate environment. Well diversified Prosper and Lending Club investors have received higher returns in the last few years than they probably would have on most other types of notes and bonds.
Good Historical Performance
Well diversified peer to peer lending investors have historically made good returns and rarely lost money.
Assistance with Due Diligence
Peer to peer lending sites such as Lending Club and Prosper generally perform an initial screening of the loan applicant. Only a very small percentage of applicants actually pass the underwriting process and are eligible to receive loans–most applicants are actually rejected due to poor credit.
This tends to give investors confidence that most borrowers who pass the initial screening have at least decent credit (if not much better). Historically, most borrowers have paid back their loans responsibly. However, there are no guarantees and some borrowers do default.
Approved loan applicants are assigned a credit rating, which determines the interest rate charged on any loan they receive, and provides clues to investors about how risky a borrower that person is.
Personal Due Diligence
Peer to peer lending sites such as Prosper and Lending Club generally provide a lot of information to potential investors about those looking to borrow money, making it a very transparent way to invest. Investors can even ask additional questions of borrowers.
Peer to peer loans have excellent diversification potential, since they most likely have low or negative correlation to many other common investment alternatives, such as stocks or bonds. In other words, even if the stock market tanks one year, as long as most of your borrowers make their payments, your peer to peer loans could still perform very well that year.
Easy to Understand
I generally recommend to people that they only invest in things they can understand. Most people understand the basics of peer to peer lending without much difficulty.
Quick and Easy
Low investment minimums and automated diversification options make it incredibly easy to invest in hundreds of different peer to peer loans in no time at all. Additionally, I’ve found the Lending Club and Prosper peer to peer lending sites to be very intuitive and easy to use, even for the technologically challenged.
Low Hurdles to Invest
An investor is generally able to lend part or all of the money any borrower wishes to borrow. Investors must generally invest at least the minimum investment amount (usually $25 or so) in each loan they choose to invest in.
By having such low investment minimums, it is quite easy for even investors of modest means, to create a well diversified peer to peer loan portfolio.
Peer to Peer Lending Facilitation
Let’s say you want to try and make money by loaning funds to other individuals. However, let’s say you decide to do everything on your own without the assistance of a peer to peer lending company such as Prosper or Lending Club. This might involve you having to do all of the following (and more):
- Screen potential borrowers and judge their credit worthiness
- Decide who you are willing to loan money to and who you are not
- Based on an approved borrower’s credit worthiness and other terms of the loan, decide on an appropriate the interest rate to charge
- Come to an agreement with the borrower on these terms
- Create a legally valid agreement
- Monitor and keep track of payments
- Take care of any applicable tax reporting
- Coordinate collections efforts in the event a borrower stops making payments
As you can probably guess, doing such a task yourself with only one borrower would be a lot of work and would be tough to do efficiently. Now imagine you want to create a diversified portfolio of loans and need to do the above for hundreds of different loans.
Alternatively, if you decide to use a peer to peer lending firm such as Prosper or Lending Club rather than spend the energy and time trying to manage this yourself, most of the heavy lifting is done for you.
Peer to peer lending companies facilitate the process for both parties, making it a much more legal, efficient, and secure way of doing things.
Improvements Over Time
Peer to peer lending companies started in 2006, with Prosper being the first company. Lending Club entered shortly thereafter. Both companies have improved their models and matured over the years and are now more experienced with assessing potential borrowers, preventing fraud, and choosing proper interest rates.
Downsides to Investing in Peer to Peer Loans
Like any other investment, there are some downsides to investing in peer to peer loans.
Peer to peer loans are not a risk free investment and you could lose some or all of your investment. They are not backed by the government or FDIC insured.
The main risk when investing in peer to peer loans is that a borrower will default and stop repaying his or her loan. Your overall returns will be lowered each time a borrower defaults since the loans are unsecured.
There are borrowers who default in every credit class, even people with pristine credit. Defaults on newer loans lower your returns more than defaults on older loans, since there will be a larger loan balance outstanding.
Peer to peer loans are more risky than other some other types of loans or notes, such as Treasury Bills. Many investors are willing to accept this higher risk for the chance to earn a much higher return on their investment. I share below how to lower this risk significantly.
Similar to other fixed income vehicles, inflation eats into the purchasing power of your returns. However, the opportunity to earn high returns with these loans does help.
Lending to Strangers
Although you can find out quite a bit about any potential borrower, you are lending money to a complete stranger.
Peer to peer loans are generally unsecured. If a borrower doesn’t make his or her payments, you may be out the money you loaned to that person.
Lack of Historical Data
Peer to peer lending is still fairly new and so Prosper and Lending Club historical data is fairly limited. Overall returns over the past few years is overall quite promising; however, past performance cannot guarantee future returns.
The terms of most peer to peer loans are several years and many cannot be resold on a secondary market. Many other investment alternatives, such as mutual funds and publicly traded stock, are much more liquid.
Peer to peer lending companies do have to be compensated for their facilitation of the loans, and so there are some fees involved. I personally think the fees are very fair for the services performed, but they are fees nonetheless, and they eat into your overall returns.
Not Available in Every State
Not every state allows peer to peer lending. You might be very interested in investing in peer to peer loans; however, if you live in the “wrong” state, you might be out of luck.
If you are interested in investing in Prosper or Lending Club peer to peer loans, below are a few tips you might consider.
Invest in Many Different Loans
We have all heard that we shouldn’t put all our eggs in one basket. This goes for peer to peer loans too. It probably doesn’t make sense to invest your entire investment portfolio in peer to per loans. It may not even make sense to invest all of your fixed income securities in peer to peer loans. Most likely, peer to peer loans should make up just a portion of your fixed income portfolio.
If you want to reduce your risk and increase your returns when investing in peer to peer loans, consider diversifying your investment amongst hundreds or even thousands of different loans to reduce the impact of defaults.
Think about it–if you invest in only 4 different loans and one borrower defaults, you’ve likely suffered a huge loss. However, if you invest in 400 loans and 3 borrowers default, your losses are minimal.
If I could make one suggestion to you it would be this: make the minimum investment allowed (usually $25 or so) in as many loans as possible. If you have $5,000 to invest in peer to peer loans, don’t fully fund a $5,000 loan. If that person stops making payments you could lose everything. Instead, invest the absolute minimum in several hundred different loans. This can help diversify away part of the risk of borrower default.
Risky investments such as peer to peer loans should generally only have a small place in your investment portfolio. Make sure your portfolio remains properly diversified and that you don’t incur too much risk. Most people would be wise to keep a diversified portfolio, spreading their investments amongst stocks, bonds, cash, and possibly a few other types of investments, such as real estate.
Remember that some peer to peer loans may be quite illiquid. Many loans have a term of 3 years or more. Don’t invest money in peer to peer loans that you will need next month.
How to Start Investing
In order to start investing in peer to peer loans, investors generally fill out a short application at a peer to peer lending site such as Prosper or Lending Club. Once approved, investors are able to transfer money to their peer to peer lending account from their bank account. They are also able to see information about the many approved borrowers and their desired loans and decide whether or not they want to invest in a given loan.
Tools on the sites make it incredibly easy to screen loan applicants using various criteria, such as credit rating, repayment history, loan to income ratio, and what they plan on doing with the money. You can generally manually choose which loans you want to invest in, or have the system choose them for you based on certain criteria you select.
You can spend hours pouring over information about potential borrowers and trying to decide whether to lend to someone or not. If you are highly diversified amongst hundreds of different loans, spending even 5 – 10 minutes analyzing each loan could take up a significant chunk of time.
My personal preference is to decide what types of loans I’m interested in and then invest in as many loans as possible that meet my criteria.
Once the desired amount of funds has been raised for a given borrower, the loan is funded and the borrower begins to make payments of principal and interest back to the investors.
Investors can choose to reinvest their loan payment checks they receive or have them deposited into their bank account.
Final Thoughts on Peer to Peer Lending
I’m not going to lie, I am a huge fan of Prosper and Lending Club. I love the concept of peer to peer lending, I love their past investment performance (although past performance may not always be indicative of future performance), and I think it can have great benefits for investors and borrowers. Personally, I am overall quite optimistic about their long term prospects.
Although they do have their differences, the similarities between Prosper and Lending Club greatly outweigh their differences. You can probably do well with either company. For additional diversification, consider splitting your investment between both.
Peer to peer lending may not be right for everyone, but I think there is a reason why many institutional investors and investment funds have begun investing some serious cash in peer to peer loans.
My personal belief is that everyone should give it some serious consideration and see whether it makes sense to invest at least a small portion of your portfolio in peer to peer loans due to the benefits discussed above.
Remember, you can always start small and then increase your investment if you find it beneficial. If you are also very risk advserse, you can reduce your risk even more by only investing with borrowers who have a pristine credit profile and are less likely to default than borrowers with lower credit scores.
What are your thoughts about peer to peer loans? How has your experience been with Prosper and/or Lending Club? Leave a comment below!