I signed with Prosper.com as an investor about six months ago and deposited $2,500. So far I’ve been happy with the site. This is my review of Prosper along with a discussion of how it works.
How Does Prosper Work?
Prosper is a peer-to-peer lending site. That means that individual borrowers apply for loans, which then get funded by other individuals. (Most of funding actually comes from institutions now). Borrowers get loans of $5,000 – $35,000 at rates of between 10 and 20 percent, depending on their credit history. All of the loans are fully amortizing and have either 3 year or 5 year terms.
Prosper assigns a credit rating to each borrower based on their own algorithm. There are 7 different ratings, ranging from best to worst: AA, A, B, C, D, E, HR. The table below shows the yield for the different credit ratings.
Once the borrower is approved, the loan goes live on the Prosper site and gets funded by investors. A key detail is that each loan gets funded by many investors. For example, a $10,000 loan could get funded by 400 investors loaning $25 each.
The picture below shows some of the loans currently live on the site. (All of these will get quickly funded within a couple days).
Prosper makes money by collecting fees from both the borrower and the investor. The rate paid by the borrower is 1% higher than the yield earned by the investor. Thus, for an A rated loan that is yielding 9.25% for the investor, Prosper is actually charging the borrower 10.25%. Prosper also makes money by originating the loan and charging the borrower a fee of 1% to 5%, depending on their credit quality. While these fees seem excessively high, remember that they are for the borrower and not for the investor.
As far as I can tell, the only fee that is paid by the investor is an asset management fee of 1% of the principal value of your notes. This seems like a reasonable fee structure, although I haven’t compared it to other peer-to-peer lending sites.
If you’re interested in Prosper’s description of their business and might want to be a lender, you can visit Prosper here.
I deposited $2,500 on Prosper and used their “Quick Invest” feature to set up automatic investing. I don’t really have time to look through individual loans. My loan size was $25 each, for a total of 100 loans. I chose this amount in order to get maximum diversification, since I expect 4-6 of the loans to default. I funded only loans with a Prosper rating between AA and D – none of the worst quality loans rated E or HR. My reasoning was based on the data on the table above: the E and HR loans didn’t seem to offer much additional yield compared to their risk.
It took about a week for all the capital to be deployed. Most of the loans I funded were of AA through B quality, with only a few C and D loans funded. Unfortunately, I don’t see a quick way on the site to identify my weighted average yield.
Initially, I had it set to automatically reinvest cash in new loans. Thus, when a couple of the loans were paid off early, new loans were funded. I wound up funding 2 additional loans for $25 each, making a total of 102 loans. At that point, I stopped the automatic reinvesting and now I’m just collecting cash.
Observations from the Lender Perspective
I’ve learned a few things so far about being a lender. When you are the lender on a fully amortizing loan, the best result is that the borrower fully makes all payments on time, at the agreed-upon interest rate, for the full term of the loan. There are two sub-optimal results for the lender:
1. Prepayments – The borrower can pay off the loan early. You get your cash back, but you don’t get much return on it. So far, that has happened on 7 of the 102 loans I funded.
2. Defaults – The borrower can just default entirely and run away with the money. I expect this will happen on 4-6 of the 102 loans I have funded. Currently, 3 of my loans are past due and they will probably go into default. Once a borrower misses a payment, I think there is almost no chance of the note becoming current again.
What Rate of Return Will I Get?
When all is done, I’m pretty sure I will get an annual return of between 5 and 10 percent. It depends on the number of prepayments as well as the number of defaults. I intend to hold the loans for at least one year.
My account is currently worth $2,637 after six months, an annualized return of about 10.2%. However, the loans are not considered seasoned until 10 months have passed, so I expect there could be a few more defaults in the coming months. After 10 months, the rate of default drops and the return figures are more reliable.
Selling Your Prosper Loan Portfolio
The terms of the loans on Prosper are either 3 years or 5 years, so in theory it would take up to 5 years to fully convert my account to cash. However, Prosper does have a secondary marketplace (folio investing) on which it is possible to sell your loans early. There’s a 1% fee for selling the loans, plus they may trade at either a premium or a discount. I don’t have any experience selling notes on the secondary marketplace yet, but I have read that they can be traded roughly at par. Thus, if I wanted to exit the loans early, I don’t believe the fees would reduce my returns much (note that I haven’t confirm this myself, just read about what others have done).
In short, I think Prosper is a good place to invest some of your cash for 1-3 years. The site is reliable, and the fees charged to the investor are very low. I expect to earn a return of between 5 and 10 percent. I’m pretty sure my return will be considerably greater than the 1.5% currently offered by 1-year CDs.
If you’re interested in signing up as a lender at Prosper, click here to go to the site.