Step3 Prophet

Exploring Prosper Part 7

This is part 7 in a series of posts on my experiences with Prosper, the peer to peer lender.

See Part 1 , See Part 2 , See Part 3 , See Part 4 , See Part 5 , See Part 6.

I've been using Prosper for over 2 months now, and I must admit that I'm overall very pleased with the service. I've got about $1500 invested with an average return of 18%. So far no defaults, but it's still very early in the game. A lot can happen in the 3 year life of the loan. With Lending Club I'm up to 9 loans > 30 days late, and I'd say my average loan age is about 6 months. I'm still very far ahead on LC because of the generous bonus they gave out in February.

One of the things I like about Prosper is the guidance they give on the manual bidding. My first 20 or so loans were done with the automatic bid program from Prosper that I edited, but even though the program is very customizable, it still doesn't cover all things I consider in a loan. (For instance, the ratio of loan amount to revolving credit balance). So recently I've been doing more manual bidding then automatic.

When you place a bid on a loan, you enter in the lowest amount you are willing to take for an interest rate. Since there are so many factors that go into the risk of loan default, choosing a reasonable interest rate on your own would be a very difficult proposition. But thanks to Prosper's loan history, they now give you general guidance on what your expected return is for a any given loan. If you expand the image to the left you can see the bid page. I entered in 20% as the minimum I would be willing to accept in interest on this loan. Prosper then factors in risk of default (estimated loss), Prosper fees, and a minor adustment for accrued interest and late fees that are not collected on loans. The bottom line is your actual expected return. For these particular loan characteristics at that interest rate, I can expect a return of 8.42%. I can adjust my minimum interest rate up or down to give me a different expected return.

Personally, I try to set the expected return for all my loans at around 7%. This is for a few reasons. First I need to stay competitive with other bidders. If I bid too high, I'll get outbid and receive no loans. If I bid too low, then when some of my loans do end up in default I won't make enough interest from the other loans to compensate for my loss. This is another area where Prosper gives guidance. If you put in a bid that gives a low expected return, Prosper will warn you of this and ask you to go back and change your bid. If you bid ridiculously low, they will even admonish you and tell you that you could earn more in a 2 year CD. Using this guidance you can put together a portfolio that will give you decent returns from a variety of credit grades. Prosper guides bidders to between 7-8% expected return depending on the credit grade.

If everything worked out just as the statistics predicted, then your return would be the expected return. However, individual lenders have a chance to beat the system here by choosing their own loans manually, or by creating a customized bidding program. My goal is to beat the average through both of those methods, giving me a return closer to 18% than 7%. Propser actaully rates people and groups on how well they beat the expected return for the loans they hold. Most groups I've seen do not beat the expected return.

My goal might be a bit audacious, like saying I'm going to beat the stock market by picking individual stocks. It can be done, but luck tends to play more of a factor than skill. P2P loans are supposed to be less risky due to the borrower knowing they owe real people and not just a bank, but I think the internet is too anonymous for that. All you have to make a decision is a 1 page summary with most of the information provided by the borrower. Only time will tell.

If you want to keep track of how I'm doing, check out my profile on Lending Stats.

An example of how NOT to diversify

I checked up on my Lending Club accounts the other day, and was surprised to see 3 new late loans. Up until now I had seen late loans slowly trickle in, but never 3 out of the blue. So I took a look at my individual loans and this is what I saw:

The three late loans are from the same person! How could I have been so stupid! I'm pretty sure I know what happened. Since Lending Club takes 14 days to close a new listing, and I was moving money to LC very quickly earlier this year, the same loan might have cropped up a few times in Lending Clubs portfolio generator. Since the portfolio generator returns about 20 loans( for a $500 input), it could be possible to overlook the fact that I already had bought a piece of that loan.

I did a quick look through my other LC loans. It turns out I have 12 pairs of loans, and 1 triplet. Some of those loans are for more than $25 each. In fact I lent 1 person $525 when I first started with LC. Looking back, it was a foolish thing to do. My first $1000 that I invested in LC, I did $500 with the portfolio builder, and went out on a limb and put the other $500 on a good looking loan. Since then I've done some research on expected returns from personal loans, and I would be much more afraid to make that same size loan again.

So to prevent such an occurrence in the future, I'm instituiting a new policy for myself. No new money to a P2P lender until the previous money has "settled", Ie the loans are issued. This means about 7 days for Prosper and 14 days for Lending Club. Interestingly, Prosper has an option in their auto bidding program to not select loans already purchased. That may actually prevent this. I hope LC institutes a similar option, assuming they every come out of this quiet period.

Does all this have me down? Not really, because when I think about it realize that the reason I was moving money so quickly was because of the bonus LC offered at the time. From that promotion, I got $370. So right now all of my late loans are more than made up for by LC's generosity.

Prosper Part 6

This is part 6 in a series of posts on my experiences with Prosper, the peer to peer lender.

See Part 1 , See Part 2 , See Part 3 , See Part 4 , See Part 5 , See Part 7

Today I spent a little time refining my auto bidding algorithm. I also moved some more money that I had received from my Lending Club loans to Prosper, since LC is still in their "quiet period" phase.

I'm actually quite impressed with Prosper's auto bidding program. The number of criteria that can be specified is quite large, as you can see from the image to the left (click to embiggen). I decided to add a few more criteria to my bidding program, specifically credit card utilization and employment data. I figure that a person who is at greater than 75-80% card utilization is in a precarious position and at greater risk of default. Also, someone who has less than 1 yr employment  status maybe a higher risk of layoff and therefore loan default. These are my gut instincts, I don't have any data to back them up.

I also decided to screen loans for debt consolidation. I'm not interested in financing someone's business startup or wedding day. I like to help people help themselves, and refinancing credit card or medical loan debt at a lower interest rate makes money for them and me.

Because of all my "refinements" Prosper is no longer able to accurately predict what my return will be based on their historical data, and so I don't have an estimated rate of return anymore. I was looking forward to beating it...or not.

I also tried my hand at bidding on a few loans manually. So far I haven't won a single manual bid, and I don't think I will either. One bid was a sympathy bid. They wanted the money to buy the same scooter I want to buy. The others look like good loans to me, but I'm either outbid or the loans are underfunded. I don't have time to deal with second guessing myself, so I'll just stick with my auto bidding plan for the most part.

Prosper Part 5

This is the fifth in a series of post on my experiences with Prosper, the Peer to Peer lender.

See Part 1 , See Part 2 , See Part 3 , See Part 4 , See Part 5

Prosper has finalized my first 10 loans and I had some extra cash lying around, so I decided to add another $250 to my loan portfolio. Since I recently setup a Facebook account, I wanted to see what this instant transfer of cash thing was all about. 

I went to the money transfer page and looked at my options. It said instant transfer was not available to me yet, but I knew if I installed their Facebook application it would let me. I followed the link to Facebook and installed their application. It may just be me, but Facebook applications are very grabby. They want access to all your info, to place ads in all locations on your page or other peoples pages that you view. I deselected all but the most basic access, and even now I want to cut it back even more. Since I'm new to Facebook, I haven't figured out what everything means yet and how to change the all the options.

Once I installed the Facebook application, I had to associate it with my Prosper ID. This only took a second to do , and then I was ready for instant transfers. With the Facebook app installed, you can instantly transfer up to 90% of the value of your current portfolio. This means I could have transfered up to $450, but I stuck with my original plan and only did $250. Sure enough, the money was instantly accessible after the transfer. Two days later, my bank account still has not been debited. So even though the funds are made available to you on Prosper, it still takes the standard 3-5 days to process a transfer.

Once funds were available, I had to edit my auto bidding program. I was thinking at first that if you had an automated bid program in place it would take any cash in your available "pool", but this is not the case. Apparently when you give the program a cash limit it only grabs enough cash to meet that limit. I had originally limited it to $500 since that was all the money I had available at the time. That meant the new money I transfered in was not instantly grabbed by the program. So I raised my limit to $750. That means that when I finally earn enough money in interest and principal payments to meet the $50 minimum, it will not automatically be entered as a bid on a loan. I'm not sure what would happen if I increased my programs limit to ,say, $800. Maybe it would then bid automatically once my cash pool reached $50? That would be useful feature. As Ronco would say, you could "set it and forget it".

Here is what my summary looks like now. Click to enlarge. I was initially confused by my account balance being $777.21 when the total of my deposits and bonuses was $775. It's too soon for any payments to have been made. Then I realized that Prosper was predicting the value of my portfolio as if interest was paid daily. This is something I do not like. It's basically counting your chickens before they hatch. Granted, I don't want any loans to default, but it will happen and that total will not be accurate when it does. Overall, I like Lending Club's summary page better than Prosper's.

Prosper Part 4

This is the fourth in a series of post's I'm doing on Prosper, the peer to peer lender.

See Part 1
See Part 2
See Part 3

See Part 5

My sign up bonus went through, and my automatic loan selection program has bought me into 9 loans with a final one on the way. That means I will have $500 invested in loans, and $25 in idle cash until I add more money or get some payments. The image to the left shows the nine loans. It's a nice mix of various credit grades, just like I set up for my auto loan bid program. The average interest rate is something like 18%, which is higher than my Lending Club portfolio by quite a bit. I think Prosper expects many more defaults than Lending club, which is why it projects my custom portfolio as having a real return of 7%.

Another difference in Prosper vs. Lending Club is the time it takes for a loan to finalize. Lending Club has a 14 day funding period, while Prosper has a 7 day funding period. This means that Prosper finalizes it's loans quicker, which is nice for lenders, but may not give the borrowers enough time to be funded. It seems like it always took quite a while to get my money fully invested in Lending club, while this was quick and painless. Score one for Prosper in that regard.

Prosper Update 2

This is the third in a series of post's I'm doing on Prosper, the peer to peer lender.

See Part 1
See Part 2

See Part 4
See Part 5

Today my money transfer went through. Prosper was kind enough to send me an email reminding me that money sitting idle is not earning interest, and I really should invest in some loans. Point noted. I'm excited to see how setting up a portfolio on Prosper differs from Lending Club.

My first option is the choice of plan I want to create. Since I don't have time to sit around bidding on loans all day, I'm going to setup an automatic plan, much like auto bidding on Ebay. I really appreciate how Prosper lays all the information out. They give you an estimated return for each of their automatic plans, and break it down by average loan interest rate, minus losses due to defaults and service fees based on Prosper historical data.

Many people who consider investing in loans are scared off because the borrower might not pay the money back. If they are unlucky in their choice of borrowers, they fear losing a lot of their principle.  Hopefully this historical breakdown will allay some of their fears. The more diversified your loan portfolio is, the more likely you will have a person default, but you will be less likely to be hurt significantly by the default. Having more loans will bring you closer to historical models of loan defaults, and you will be better able to quantify the risk of default. There is protection from the individual risk of a loan default by investing in more loans, just like there is protection from individual companies going bankrupt by investing in a broad market mutual fund. This is where interest rates make a difference. If you invest in higher risk loans, a higher interest rate is needed to make up for the higher number of defaults. Some loans will defiantly go bad, but the ones that do make it to full repayment will make up for those losses.

This is also where Prosper fails the lender and helps the borrower. Because interest rates are "bid" for, the final interest rate may not reflect the real risk associated with any particular loan. For lenders, if many loans in your portfolio are like this, when defaults occur you will not be adequately compensated by other loans in your portfolio and your returns will be below expected and possibly negative. For the borrowers, this means they  may get a loan more cheaply than a conventional institution would ever consider allowing.

I decided to make my own custom plan. Interestingly enough, after adjusting all the criteria to suit my preferences, Prosper estimates that my real return will be somewhere around 7%. I think I'll do better, but only time will tell. My main customizations where to limit the Debt to income ratio < 20% [prospers maximum is 40%]. With fear of recession abounding, there needs to be room for people's budget stay flexible. The bigger the DTI ratio is, the less flexibility a borrower has in their spending, and I bet loans will default before people give up their home or food or car. Another thing I don't like about Proper is the $50 minimum bid. Lending Clubs had a $25 minimum, which means you could get 20 loans for $500 vs 10 loans on Prosper. As noted above, the more loans you have, the more quantifiable your risk is. Starting out with 10 loans leaves more room for bad  luck than a larger sample of loans. I expect my loans will grow as I invest more. Another scary thing is the lack of review. With the automatic plan, bids are made for me and can't be undone, only out bid. I have a predilection for people who are getting out of credit card debt, but I don't think that is a criteria I can select. Oh well, I'll just have to see what my plan turns up.

Prosper Update 1

This is the second in a series of post on my exploration of Prosper. the peer to peer lender.

See Part 1 , See Part 2 , See Part 3 , See Part 4 , See Part 5

Today the trial deposits posted to my account. Prosper uses a method I haven't encountered before, the trial deposit and withdrawal. As in, they deposited 21 cents and withdrew 4 cents. You have to know both amounts to authenticate your account. I've seen the two deposits before, and I've seen companies take there deposit back, but never has the withdrawal been part of the authentication. So I set up my account and initiated a funds transfer.

During the funds transfer process there was an option to do an instant transfer. This is something I've never seen before. Often times I'm frustrated by having to wait 3-5 business days for money to actually move. To qualify for instant transfer you must meet certain requirements, which I can't meet yet. From the website they are:

• Transfer amount must be between $500 and $10,000
• Sum of pending transfers must be <20% of lender's active loan value
• Your active loan value must be at least $2,500

Obviously someone who just signed up can't meet these criteria, but maybe later I'll take advantage of it.

After initiated the funds transfer I decided to explore the website a little. One of the things I noticed is that the potential earnings could be much greater. Some loans started at over 30% interest rate, whereas the highest interest rates at Lending Club were around 20%. However, the higher interest rate is due to a greater risk. Prosper doesn't observe the same minimum loan requirements that Lending Club does, so interest rates have more variability. Another thing that occurred to me is that interest rates on Prosper don't necessarily reflect risk. Because of the Ebay like process of bidding on loans, the interest rate a borrower pays can be substantially less than their actual risk level. Probably the biggest factor is the Debt-to-Income ratio of the borrower.  For a more in-depth post on how this affects loan risk, check out this post.

Some other differences I've observed between LC and Prosper. On Prosper, borrowers can post a picture. This adds a human element to the process, but hopefully that won't be a factor in my decision. Unless they post a really stupid picture. Like LC you can ask the borrower questions. Additionally, borrowers can have friends write character endorsements for them. You also get a credit summary, just like LC, but the borrowers are required to go into more detail about their expenses. Since that part is unverified, you can only trust it so far. The credit report is your only outside objective look at the credit risk of the borrower.

Prosper has been around longer than Lending Club, and so these feature may be coming to LC in the future.

Exploring Prosper

I've written several entries about Lending Club in the past, but since they've entered their "quiet period" I can't really do much with them except watch my loan farm reap interest. The money that gets paid back just sits in a non-interest earning account since I can't reinvest it. I promised myself that if it reached $500 while Lending Club was still O.O.C. then I would give Prosper a try, and that limit has been met. Prosper is the other major contender in the world of peer to peer lending. I've avoided Prosper up until now because I had several issues with the way they do loans. It continues to amaze me that two companies who do exactly the same thing can be so different in its execution. I guess it make things interesting. To put it succinctly, Prosper is to Ebay as Lending Club is to Amazon. So in this post and some future ones I'll explore my experiences with Prosper.

Today I signed up for a membership. This took about 2 minutes, which was basically just giving them my name and email address and choosing a username and password. You activate your membership by validating your email address with an email they send you.

To actually do anything though, they need to validate your identity. The things they ask for are your name, social security number( this is for tax purposes as well) , date of birth, and drivers license number. A bank account is also necessary to transfer money to and from. Once you've given them that information, they verify your identity through Experian. After all the forms were filled in they asked me 4 multiple choice questions based on information from my credit report.

Interstingly enough, the fine print makes it clear that a "Lender" is actually purchasing promissory notes on loans made by WebBank of Utah. So you are not lending people the money directly. The loan is made by the bank and then resold through Prosper to lenders and is serviced by Prosper. The fine print also points out that the maximum amount of loans a lender can have is 5 million. It will be awhile before I reach that limit. During my account setup I took too long to read the fine print and it logged me out.  Luckily for me, it remembered all my information, so as soon as I logged back in I completed the process.

After identity verification comes bank account verification. There were two options for this, instant verification and trial deposit verification. For instant verification you provide your username and password for you bank's website as well as 3 security questions. I can only assume those are the security questions you gave your bank, and I can't remember what my were, so I elected to go with trial deposit verification.

Since trial deposits take a few days to post, that effectively ends my process for tonight. On Thursday or Friday I'll confirm my bank info and initiate a funds transfer.

See other posts in this series:

See Part 1 , See Part 2 , See Part 3 , See Part 4 , See Part 5

Running some numbers on Lending Club

As promised earlier, I'm going to do some calculations to see just what kind of returns you can get from a Lending Club investment. I'm specifically going to consider three things: (1) The maximum return you could expect from an "average" investment. (2) How many loans you can have default before you break even or lose principal. (3) What the most realistic scenario would be based on my own portfolio and historical trends.

For the first question, I'm going to assume an investment of $1000 at an average rate of 12% interest. This assumes no reinvestment and no defaulted loans. An interest rate of 12% looks good, but remember this is a loan, not a certificate of deposit. That means the principal goes down each month therefore the amount you are getting paid interest on goes down as well. So over the course of 3 years, you would receive a total of $195.72 in interest payments, and the return of your $1000 investment. That is equivalent to a annual rate of return of about 6.5%. When you factor in that LC charges you 1% of each payment in processing fees(thats principal and interest), your actual return is $183.76 and APY of 6.13%. What this means is, if you can find a secure investment with a APY of 6.13% you are better off putting your money there than in a loan portfolio. But I bet you can't find that kind of return right now in the USA. Of course, this is a best case scenario. What if you had some loans default?

Adding loan defaults into the equation complicates things greatly, because how much interest you make  and how much principle is returned depends on when the loan defaults. To simplify matters, I'm going to look at a worst case scenario in which all loan defaults happen before the first payment is ever made. Since $25 is the minimum you can contribute to any particular loan, I'll assume the original $1000 is divided into 40 loans for at $25 each. Also, I'll assume the loans that default do not affect the average interest rate. For beginning defaults you see:

Loan Defaults	Return	APY	% default
0	$1,183	6.10%	0.00%
1	$1,154	5.13%	2.50%
2	$1,124	4.13%	5.00%
3	$1,094	3.13%	7.50%
4	$1,065	2.17%	10.00%
5	$1,035	1.17%	12.50%
6	$1,006	0.20%	15.00%
7	$976	-0.80%	17.50%

As the table shows, you can sustain up to a 15% default rate before losing principle. However, that would leave you with zero gains after 3 years. A better scenario is a less than 5% default rate. Keep in mind that this if all defaults happen at the beginning. You could have every loan in the portfolio default on the final payment and it would be like having 1 loan default in the beginning.

Finally, a closer look at my own portfolio and what kind of returns I expect. I'm continually reinvesting my returned principal and earned interest. In this manner I'm able to maintain the high rates of return given by the advertisements. My portfolio average right now is just about 14%, so after a 1% fee(on principal and interest) my actual returns should be closer to 12.8%(ideally). What kind of defaults do I expect? (In my dreams I see zero defaults, but reality isn't that nice). Adjusting for the weighting of my portfolio, my risk of default based on historical data should be :

Loan Grade	Actual Portfolio make up	Average Grade Default Risk	Weighted Risk
A	6.00%	0.47%	0.03%
B	5.00%	1.26%	0.06%
C	12.00%	2.05%	0.25%
D	19.00%	2.84%	0.54%
E	25.00%	3.63%	0.91%
F	16.00%	4.42%	0.71%
G	17.00%	5.21%	0.89%
		Average Risk	3.38%

This compares favorably with the previous table. For a loan portfolio earning 14% average, we see that for every $1000 invested(without reinvestments):

Loan Defaults	Return	APY	% default
0	$1,218	7.27%	0.00%
1	$1,187	6.23%	2.50%
1.35	$1,171	5.70%	3.38%
2	$1,157	5.23%	5.00%
3	$1,126	4.20%	7.50%
4	$1,096	3.20%	10.00%
5	$1,065	2.17%	12.50%
6	$1,035	1.17%	15.00%

So an equivalent guaranteed investment would have to earn 5.70% APY before it would be a better investment than a loan portfolio. Obviously you can't have 1.35 defaults before the first loan payment, but as the loan base gets larger it should more closely resemble the historical data. Again, this data ignores reinvestment of returned principal and interest.

Here is the spreadsheet I used to calculate this data: Download loan_vs_cd_caculator.ods It's an Open Office document. In another six months I should have enough real world data to see how accurate the model is and what actual rates of return are.

P.S. One of my late loans paid up, so now I currently have 2 loans that are past 30 days due, which means a potential default rate of 0.9% right now. It's not technically default until 120 days past due, but any loan 30 days late is not something you can count on.

Why I like Lending Club

Lending Club(LC) is a peer to peer lending provider. Basically, people need money, other people have money spare, and LC brokers the transaction between them for a small fee from both parties. If it was just a transaction between 2 people, the lender would be in for a big loss if the person is not able to pay it back, but what lending club allows you to do is lend a small amount to many different people. This allows you to mitigate the risk of a single person defaulting on a loan while still earning a good rate of return. Right now the banner on the website advertises a 12.43% rate of return. That's a spectacular rate of return if it could be maintained, but there are a few not so obvious caveats in that number which I'll get to later.

Some things to consider when you want to invest:
    (1) You will not have access to all of your money for 3 years (the standard loan term). Your money is repayed in 36 chunks, maybe sooner if borrower wants to pay it off more quickly.
    (2) It pays interest just like a house mortgage( ie less money in each payment is interest earned, more is principle repayment). To maintain high returns you have to reinvest your payments received, just like dividends in the stock market.
    (3) You could lose 100% of the money you invest. Thats why you are getting higher returns than an insured investment like a CD or T-bill. Even so, the likely hood of every loan you invest in defaulting is quite low. The trick is to figure out how many loans you can support going bust before a CD looks like a good investment.

So what do I like about them?

For starters this is how banks make money! The money you deposit in the bank gets loaned out again to some sub-prime wanna be homeowner at potentially ridiculous interest rates, while your savings account earns a measly 3% if you're lucky. With LC you can cut out the middle man and go straight for the profits *see risk statements above* The loan rates go from 8-18% and risk varies accordingly. This realization  is what  convinced me to  invest with LC.  There is profit in the loan industry or else banks wouldn't be in business.   

I'm helping people out. Most people seeking loans are people who got stuck with high interest credit card rates (20-30%+) and I'm helping them get a better handle on their finances by consolidating and lowering their monthly payment. Of course, not every borrower has learned how to be responsible with credit cards and some will run their cards up again, but I'm willing to give people a hand, especially if it's in my interest to do so. Some people need loans for business startups or new mattresses, and those I scrutinize a little more carefully. (the mattress is one of my loans that has gone late :-( )

It's an investment that does not correlate with stocks or bonds. Even if the stock market tanks, this investment should still turn a profit as long as there are not too many defaults. Right now I have about 100 dollars in late loans, but I've earned 170 dollars in interest. The 12% returns advertised on lendingclub's website are not the full truth, but my gut instinct tells me that the rate of return must be better than a CD or else how could banks afford to issue certificate of deposit?

That last statement is probably my biggest mistake as an investor. You should always fully understand the risks before investing in anything, be it stocks, real estate, or Peer to Peer loans. I've promised myself to actually run the numbers for a post later this week, so then I'll know the whole truth.

To finish, here is a shot of my summary page. Click to enlarge. The website is www.lendingclub.com If anybody wants to  sign up, shoot me an email  and I'll send you a referral. It gives a bonus $25 dollars for you and me.