Prosper.com: Not a Lender's Market

The novel concept that Prosper.com brings to the whole concept of loaning is intriguing; following the eBay model of determining a true market price and putting lending in the hands of consumers has a certain revolutionary flair. But perhaps the site should not call itself peer-to-peer lending, so much as peer-from-peer borrowing. Some places are a buyer's market or a seller's market; Prosper.com is a borrower's market.

Chances are if you're reading this article you know what the Prosper.com peer-to-peer microlending model is all about. People put up loans detailing their credit history, their goal (or sob story), and, of course, how much they need at what rate. Lenders then bid on loans to get them funded. The idea is that the borrower gets his loan at a far safer and saner rate than a credit card or bank or (the horror!) payday loan company would provide, and the lender gets to score a little side money.

It is true that Prosper.com allows borrowers to, well, prosper; predatory loan companies have been around since first man learned to break his fellow man's kneecap, and Prosper.com provides a marketplace to get a loan at a better rate. But lenders may not enjoy the same success.

The high rates on the site are tempting; one can lend at 10%, 18%, 27.25%, you name it. But this rate is over three years, and Prosper does not provide a simple APY to compare this rate with your friendly savings account. Even the simplistic notion of dividing the rate by three gives a prospective lender a better picture. Sure, it's safe to lend an AA-credit-rated guy a thousand bucks at 3% over three years, but your local bricks-and-mortar savings bank can give you a CD at a better rate. And even safer.

For example:

Your correspondent has just made a Prosper loan of $50 at 20% to an enterprising Kansan. Sounds like a good rate; Prosper tells me that after fees and surcharges and the other behind-the-scenes magic, that $50 is scheduled to turn into $66.96, assuming no default. But over three years, that means I'm only getting an APY around 10%. This is comparable to the stock market, which, granted, has been bouncy lately.

To loan to someone at 20%, one often has to choose a borrower with fairly sketchy credit. Safer loans for borrowers with better credit result in lower APYs. And we can get 5% in money markets and savings accounts and CDs these days. Shopping around the peer-to-peer lending scene for a rate you want and the peace of mind you need may be a tougher task than initially estimated.

This is not to say that Prosper.com ought to be avoided as a moneymaking strategy. It's nice to have a diverse variety of passive income streams. Indeed, for a Prosper lender, it's best to diversify even within loans; putting $50 on ten loans is safer than $500 on one loan; which situation would you rather be in should one of your loans default?

And there's a tax advantage you get over hiding your money in more traditional investments; like most places (but unlike a bank), Prosper.com doesn't report your income unless you make over $600 in a year, so you can hide a few cents of profit from Uncle Sam. Stick it to the man!

But 'the man' doesn't just include the government, to be sure. Microlending in a peer-to-peer fashion eliminates the middleman and puts the profit in the hands of the people. It's fun to play bank (or loan shark!), and it's nifty to be part of something new.

But it's even more fun to be part of something that helps people. That is the true reward, for lenders, on Prosper.com; a chance to know that your money went toward helping a family rebuild their life, or a smart kid's college education, or an upstart business with nothing but a loan and a dream. What peer-to-peer lending lacks in secure profitability it makes up for in social fulfillment. Money lent to a good cause can mean the world to the borrower, and the world to the lender plus a few bucks interest. But only a few.

For the prospective borrowers, of course, this is great news. The market and the world are yours. Go forth and Prosper.