Tuesday, June 2, 2015

New Financial Product: Peer to Peer Lending

One day when surfing the web, I happened on to a new type of investment, "peer-to-peer" or "marketplace" lending.  Basically it is a loan product where lenders (investors) lend money to borrowers through an intermediary company that did the underwriting and collecting.  Average returns near eight percent were promised.  Surely, that couldn't be right.  Surely there had to be something funny going on. Surely it was like those multi-level marketing schemes were a few did get rich, but most people didn't.  It couldn't be as good as it seemed, could it?

This chart summarizes Peer-to-Peer lender, Lending Club's claims about investor returns.  In short, as long as you have more than 100 notes ($2500 invested, if you buy new notes) your chances of actually losing money (as long as current trends in repayment continue) is very low.

This chart shows that the more money you have invested with Lending Club, the harder it is to stray very far from the norm of about 8%.  You can see both of these charts, along with other information, at Lending Club's website.  

This definitely caught my eye and I headed over to Google to do some more research.  I learned that the concept was pioneered by Lending Club's main competitor, Prosper. The product both offer is unsecured personal loans to people considered to be reasonably good credit risks--in other words they are doing what banks have been doing for years via credit cards.  As my brother, the used car salesman said "I can make money lending money to any type of person; I just need to price it correctly".  Unfortunately, Prosper's first model was that lenders bid on loans and since the lenders were amateurs, they did not price the product correctly and most lost money.  

One interesting thing about both Prosper and Lending Club is that they allow interested parties to download their historical databases so they can analyze the data and learn what they can from it.  Nickle Steamroller is a website that hooks into that data and then allows you to filter it to determine the historical performance of loans of various characteristics.  Overall, the rates of return shown there do not appear to be close to 8%, but playing with back testing filters, it does not seem impossible to get good returns, especially compared to what the bank is paying.  One thing I did note was that returns have gotten progressively better and that when you look at the three year loans issued in 2010 and 2011, the return on investment (interest, minus fees, minus charge-offs) was close to 6%.  

We decided to put some of our money into Lending Club to see how it worked. You can read about my experiences on my other blog, though I will be writing more here later.  In short, so far I've been happy with my investment and, while I do not claim any real expertise in financial matters, I encourage you to research peer-to-peer lending to see if it is the right place for some of your money.

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