Retiring Early

Sunday, October 29, 2006

Prosper.com Strategies (Part I)

Since I started loaning money on Prosper, I have been coming up with my own heuristics for who, how and when to lend money. I still only have $1000 deposited and only a handful of funded loans so far (it takes a while!). Anyway, here are some of my initial learnings and habits to make the process of loaning on Prosper less risky and less time consuming. Some of these are (hopefully) insightful and others, just common sense:

1. Spotting good borrowers. To maximize the rate of return for any particular loan, you want loans that effectively balance between someone likely to default and someone who will pay off early. People on the downward spiral of multiple delinquencies (both current and over the past 7 years) need to be avoided. On the other side, anyone who willingly writes in their description that they don't really need the money or that they intend to pay it off early is probably not what you want either. It takes a while to get a loan funded so having someone turn around and pay it off early is frustrating. Balancing these two extremes takes some research, but once you get the hang of it, you will be able to spot them quickly going forward.

2. State interest rate caps. Some lenders claim that they cannot offer interest rates to lenders above a certain amount due to their home state's regulations. These rate caps do exist, and generally people from states with low rates are people you want to skip. This is especially true for people who have really bad credit and can only offer a nominal lender rate (i.e., Kentucky has an 8.25% cap!!). These people are not going to get loans on prosper, as most lenders are going to wait for loans in states where the cap is higher or non-existent before committing to a lot of risk in low-cap states. This will ultimately limit the prosper marketplace size.

3. Verified homes/accounts. I personally feel more secure lending to people with verified homes and verified bank accounts. In my mind, this lowers the risk, even with a D rating.

4. Loan search criteria. When looking for new loans, I generally exclude credit grades of E and below, ignore group affiliations (see below), although group ratings can sometimes be helpful. Again, these are my habits, yours may vary.

5. Tracking loans. When I find loans that I want to track, I put them on my Outlook calendar with a reminder for a few hours before they end. Given the chaos and tendency for lenders to aggressively bid down the lender rate, I don't waste time putting in my lowest bid and hoping I don't get outbid -- it just takes too much time to manage. I want to track the loan only just before it closes. (sorry MapGirl, but I may have been one of the snipers you encountered. :) Once the chaos in the marketplace settles down a bit and more borrowers can sop up the lending demand, I may be able to use bidding system more reliably.

6. Follow the herd. I hate to say it, but following the proverbial "herd mentality" seems to have some benefit on Prosper (i.e., using the wisdom of the crowd may be a way to minimize risk, while getting a reasonable return.) If there are lots of bids for a particular loan, there is probably good reason, if not: again, there is good reason. Loans that become fully funded early are a good sign, although the lender rate can plummet near to when it closes. The other side of the spectrum are loans that have anywhere from a handful of bids to no bids at all. Trust me, the lender community is VERY active on prosper, so odds are that you aren't the first one coming across a great undiscovered gem of a loan. A little checking on the borrower background (within the Prosper site) is usually enough to tell you to stay away. I don't mean to make light of anyone here, but here is an example of bad stuff lurking beneath the surface. (hint: look at the credit information detail after logging in)

7. Loan descriptions. The more detail in the description the better, but no matter what it says, the credit information numbers should be how you make your primary decision to loan. There are a lot of descriptions out there intended to tug at the emotions, or descriptions that provide merely a sentence or two on why someone should loan them $10,000. Remember, this is an investment, not a charity lending board. Here is an example of a good description. Here is a bad one. (I don't know how long these loan requests will be live, so check 'em while you can.)

Some things I'm not quite sure about yet:
  • Automatic Funding. This option is used by borrowers who want the money fast and don't care as much about the interest rate. Sounds risky to include these folks to me. See #1 above -- they may be able to pay it off early, denying you full interest payments.
  • What is better with all other things being equal: a positive debt to income ratio or a better credit grade?
  • Groups: I know they are supposed to give lenders confidence, but the fact that they are taking a cut means there is a conflict of interest. I am not sure what to think about groups and I currently pretty much ignore them. I am sure there is money to be made by joining one, but again, seems like there is a real conflict there.

Disclaimer: This list of learnings is not an endorsement, nor is it a recommendation on how you should invest in loans on Prosper.com. This information is provided as-is and I make no warrantees as to it's accuracy or applicability to your dealings on Prosper.com. Simply put: do your own research and draw your own conclusions. :)
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4 Comments:

  • At 11/01/2006 1:15 PM, Anonymous Tim said…

    Good article on Prosper. Thanks for stopping by my blog.

     
  • At 11/02/2006 4:24 PM, Blogger Finance Junkie said…

    In #3 you stated:

    "I personally feel more secure lending to people with verified homes and verified bank accounts. In my mind, this lowers the risk, even with a D rating."

    Verified bank accounts is a misconception that I had early on in my Prosper experience. Prosper will not allow a loan to officially fund if they cannot verify the bank account. You get some of your sweetest returns from bidding on those that don't verify or delay verifying their accounts until the last minute.

    As for homes verified, I personally bid on these w/ more caution b/c they typically have larger monthly expenditures (mortgage, taxes, insurance, etc) than renters from the same geo-area.

    I view home ownership as favorable only if they have considerable equity that they advertise in their listing or in correspondence w/ the lender(s).

     
  • At 11/02/2006 7:12 PM, Blogger fin_indie said…

    Ah, great clarification on the verified bank point. I'm learning new stuff all the time.

     
  • At 2/05/2007 3:52 PM, Anonymous RateLadder.com -- Prosper Lending, Loans, and Debt Strategy said…

    I write a Blog on Prosper Lending: RateLadder.com

    I use standing orders exclusivly:
    http://rateladder.com/2007/01/15/new-standing-order-prosper-lending-strategy/


    RateLadder.com explores all aspects of lending on Prosper.com using personal experiences as examples while adding rigor to my own journey. Always looking to improve return on investment and reduce risk.

     

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