Mortgage Opportunities – New Take on Lending Opens Field to Many

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RISMEDIA, Feb. 12, 2008-(MCT)-Andrew Meade needed to borrow $15,000 for 60 days to close a real estate deal, but he didn’t want to go through the hassle of getting the loan from a bank.

He turned instead to person-to-person lending and had the money in a matter of days. He repaid the loan in full within 60 days and discovered a new investment opportunity.

Meade, a University of Nebraska-Lincoln graduate and lawyer in Houston, said he now has about $10,000 distributed among a number of small loans on Prosper.com, an online people-to-people lending marketplace founded in February 2006. Prosper.com members list and bid on loans in an online auction format.

People looking for a loan list the amount needed, up to $25,000, and the maximum interest rate they are willing to pay. They must also state the purpose of the loan and often post a photograph.

Potential lenders browse and bid on the loans offering the lowest interest rate they are willing to accept. The loans are unsecured and have a three-year term, but there are no prepayment penalties. Lenders can fund loans in their entirety or in increments as small as $50.

Person-to-person lending has created a “new asset class,” said Chris Larsen, co-founder of Prosper.com.

Larsen said the average person has the opportunity to participate in the consumer lending industry, while earning better returns than a savings account.

Lenders are emotionally engaged within the marketplace because they are deciding which loans to fund, at least partially based on the personal stories of borrowers, he said.

Lenders also have access to financial information about people seeking loans, which includes their debt-to-income ratio and an assigned rating based on their credit score.

For borrowers, the most common reason people turn to Prosper.com is to consolidate more expensive debt, Larsen said. The next most common reason for seeking such a loan is to start a small business or continue funding a business.

Another part of the appeal of the site is that it has a “social networking feel,” said Jim Bruene, editor and founder of Online Financial Innovations, which publishes Online Banking Report.

Prosper.com tries to build social capital by encouraging members to invite friends to join and allowing members to endorse one another to help build confidence in borrowers, Larsen said. The ratings system is similar to the seller ratings on eBay that help to determine the reliability of users.

The hope is that borrowers will place more emphasis on their Prosper.com obligation because there is a reputation factor that doesn’t exist with institutions, Larsen said. “Your good name is at risk if don’t pay, so there is more of a personal relationship.”

But there is more at stake than just your reputation if you decide to quit repaying your loan. Prosper.com reports loans that are more than one month late to a collection agency on the lender’s behalf, resulting in a ding on the borrower’s credit score.

Several bankers and consumer credit counselors who were asked about person-to-person lending were unfamiliar with Prosper.com and declined to comment.

When one of David Gerdes’ friends needed a $1,000 loan, Gerdes turned to Prosper.com.

“There was no way I was just going to just give him $1,000,” said Gerdes, an information technology specialist who lives in La Vista. “Sometimes when you loan money to a friend, you lose the money and the friend.”

He said the legally binding promissory notice his friend signed for the loan, plus the fact that Prosper.com reports to credit bureaus, made him feel more comfortable about making the loan.

Gerdes has an additional $1,000 invested in $50 increments in a number of Prosper.com loans. He said he generally lends to people with top-rated credit to minimize risk and that while he has received a few late payments, none of his loans has defaulted.

The interest rates on his loans vary from 7.5% to 22%, he said, and he has averaged a 13.3% return on his investments so far.

Meade, meanwhile, said he has had a 16% return on his investment over the last 1 1/2 years because of his more aggressive style of lending to those with a lower credit rating.

The higher interest rates yield better returns as long as the borrowers keep up on their payments, he said. Meade said that about 20% of his highest risk loans have defaulted, but on those that don’t default, he gets 24% or more in interest. Like Gerdes, Meade said that none of his lower risk loans has defaulted.

Meade’s experience with defaulted high-risk loans is not uncommon, said Bruene from the Online Banking Report.

Loans made to people with weak credit records or little credit history on average have not had great returns so far, he said.

Bruene said this is especially true of the first group of Prosper.com loans, which included a high number of defaults. Prosper.com has since added more controls and regulations, and investors now have access to more information about borrowers to help make decisions about who gets their loans, Bruene said.

“In the lending business, it’s hard to know immediately if you’ve done a good or great job until 18 to 24 months after the loans originate,” Bruene said.

It might still be too soon to fully gauge Prosper.com’s success, he said, because the revised underwriting process should greatly improve future returns and decrease the default rate.

For lenders, one important consideration is that “you are putting the entire amount of your investment at risk — you could lose every penny,” Meade said.

Also, if there is even a slight chance that the lender might need the money before the three-year term ends, then Propser.com is not the place for it, Meade said. Lenders are not allowed to recall the loan early. On the upside, the rates of return for conservative investors will probably be higher than similar investments in bonds, CDs or money-market funds, he said.

That has been the case for Gerdes, who said the personal and financial rewards keep him reinvesting in Prosper.com.

“I feel like I’m helping people by lending them the money,” he said, particularly people who feel trapped by credit card debt. “One late payment and the rates are astronomical,” Gerdes said. “I can give them a better rate than what they have at the time.”

Person-to-person lending allows you to help those people build credit and get a foot in the door, Gerdes said.

Bruene cautioned that Prosper.com loans are not ideal for everyone. If you have perfect credit, it is not the place for you, he said. But it might work for recent night school graduates or people who want to start a business but don’t have enough credit history to get a loan, Bruene said.

“Lots of people fall through the cracks,” he said.

Copyright © 2008, Omaha World-Herald, Neb.
Distributed by McClatchy-Tribune Information Services.

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