Saturday, February 4, 2012

Peer to Peer Lending


In a totally different direction from my normal posting which revolves around technical / programming questions I'm going to spend some time tracking my venture into peer to peer lending. I'm a twenty something professional and I'm attempting to find intelligent places to invest money. I've got a 401k, I have some money in a brokerage account invested in equities, and I've got some in cash in savings, etc. Next I've begun playing in the peer to peer lending space.

What Is P2P Lending?

This isn't quite so scary or random as it sounds. I'm not going around soliciting random people asking if they'd like to borrow money from me, rather I'm making use of third party services. There are two main players in the United States: Prosper and Lending Club. They've had very different histories, but both have been in the news sporadically in the last few years, especially while banks have been hesitant to lend to any but the most credit worthy individuals. (Specifically I've seen many different articles about small businesses turning to this type of funding when they need capital.)

The idea is pretty simple, find people who want to invest money and connect them with people who need to borrow. Of course there is a lot more to it than that. Due diligence is necessary. Are the borrowers who they say they are? Do they make as much money as they say they do? What kind of interest rate should they pay based on their credit history, income, and assets? These are all things companies like Lending Club and Prosper take care of for you. From an investment perspective all you need to do is decide what your risk appetite is. They both have various ranking systems (which I won't go into detail on -- but which the sites describe in depth) which range from people with excellent credit, low risk and returns, to people who have a more spotted past and who pay a much higher interest rate.

What's The Catch?

But wait, this is scary, right? What if the person stops paying? Default is always a risk, your money is not 100% guaranteed, but in an environment where you're lucky to see 3/4 of a percent APR from a 'high-yield' savings account, it takes some risk to get a return. This is not a savings account. That said, it is less scary than it sounds. While you can purchase the entirety of a loan, it is highly discouraged. Rather you can buy as little as $25 of any given loan. So if you take $2,500 to start with, you can buy $25 chunks of 100 different loans. Then if one person defaults, you've lost only the remainder of interest+principal on that note.

All this said, realize that P2P lending is largely an illiquid investment. Think of it as something more akin to a bond or a certificate of deposit. They can both be liquidated readily enough, but you'll most likely take a hit when doing so. There is a trading platform for notes (both services have a platform but they do not trade with each other, only users of each site may trade with other members). Every month you'll get a payment on a note which will include some money that goes towards the note's principal and some which goes towards interest. The principal is simply you getting your base back, the interest is your profit here. (Don't get too excited when you see that you're getting $100+ / month on your $5k investment.) You can, of course, choose to take the interest back out as profit, or you can reinvest it and allow your money to go back to work for you.

What I'm Doing:

I've decided to try out both sites and see which one I prefer. I've allocated $5,000 to each as a test investment and I intend to reinvest my profits. I may also allocate additional funds later if the downside risk is truly as minimal as the statistics make it appear. After a month and half on prosper and half a month on lending club, I can say they each have their own benefits.


  • Allows automatic investments based on your filters.
    • This is really nice as it means that as soon as you get at least $25 in payments it'll push those into new notes and maximize the compounding effect of reinvestment.
  • Very broad / flexible filters
    • Lending Club has filters as well, but they only seem to allow you to make very broad restrictions
  • Higher interest rates
    • Prosper tends to have a higher range of risk, that is they allow people with lower credit scores than Lending Club, and at most levels just seem to charge a slightly higher rate of interest than Lending Club
  • Takes their money by playing the borrowing/investing spread
    • They advertise 8% to a borrower, for example, and 7% to you, and then they take 1% of the resulting interest payments from the borrower
    • Lending Club takes 1% of your payments directly so it is possible, if unlikely, that you could loose money, if a person takes out a loan and pays it back in full, in a month, you could end up with less principal than you started, this couldn't happen with Prosper
Lending Club:
  • Volume
    • Lending club flat out has more loans than Prosper, roughly twice as many loans which means there's a lot more loans out there for you to invest in
    • More loans means you can get your money invested faster and it's easier to narrow down your filters without fear of getting too specific and ending up with a pool of loans that's too small
  • Less risk
    • Lending Club has higher credit standards than Prosper and the majority of their large pool of loans are A or B rated, the returns are lower, of course, but this can be a good thing depending on your risk appetite.
Full Disclosure:
  • Prosper: First invested 12/21/2011
  • Lending Club: First invested 1/9/2012
  • $5,000 to each account
    • ($0.17 more in LC due to their bank account verification in which they withdraw a small amount)
  • In both accounts I've gone for a mix of high interest loans (I've outright excluded most AA rated loans on Prosper and A rated loans on LC to boost my return rates)
That said, it's February 4th, 2012. About a little more (and less) than a month in. Let's review!

Payments received:$146.74
Principal paid off:-$87.42
Payments in excess of principal:=$59.32
Principal charge-offs:-$0.00
Gain/loss to date:=$59.32
Principal value of active notes:$4,987.58
Total active notes:190  
   Past due (1-30 days):1  
   Past due (31+ days):0  
   Payoff in progress:
Total charged-off notes:0  
Total notes paid in full:0  
Total notes sold:0  

Account value as of writing: $5,062.82

Lending Club:
(includes In Funding)
( $5,000.00 )
Principal Received:$0.00  
Note Interest:$0.00  
Late Fees Received:$0.00  
Collection Fees:$0.00  
Service Charges:( $0.00 )
Withdrawals:( $0.00 )
Pending Withdrawals:( $0.00 )
Referral Bonus:$0.00  

Account value as of writing: $5,015.54*

*Lending club counts 'accrued interest' as part of your account value, the amount of interest you are owed up to a given point of time and does not actually reflect any guaranteed earnings -- the cash value of my account is still $5000.17 as my investments are still too new to have received payments yet.


I can't draw any meaningful results from my Lending Club account yet as it's obviously two or three weeks newer than my Prosper account and isn't even fully invested yet (about 8% of it is still pending). But I'm positive on the results of my Prosper account. I have one note which is <15 days late. It is possible it will go into default or that it will be brought back to current, but even if it goes into default, the gains from the rest of my loans already more than cover it. I'll check in again next month and see where things are at. So far I think it's a great alternative to leaving money in Savings. (I do not need it for an emergency fund as I have other liquid assets available elsewhere -- obviously this is not a good alternative to an emergency fund as it is not liquid at par.)

Before you start!

If you've found this looking to try out a peer to peer lending service, be aware there are some great tools at your disposal. All loan information from Prosper and Lending Club is accessible. People have used this to create some awesome pages and tools that allow you to create filters and then benchmark them against historical loans so you can see how well, or poorly, a given subset of loans performs. One such web page is I highly encourage anyone looking to get involved in P2P lending to play around with this page before investing. Also, remember to diversify! This can be said of any investment, but why buy one $2500 loan when you can buy a hundred $25 loans?

See the second update.See the third update.