Let’s Talk About Peer-To-Peer Lending

A synopsis:

Peer-to-Peer lending is when individuals loan money to other individuals who need loans.

An Analogy:

Remember when Napster first existed? The idea was that you had a song on your computer that was typically in a format known as mp3. You most likely listen to mp3s to this day through programs like iTunes, Spotify, Google Music, Pandora, etc. With Napster, you shared this song with other people through its software. This was the first time we started using the phrase, “peer-to-peer” on a daily basis. You are a peer, and you’re providing your favorite songs to another peer, or group of peers, people just like you. Peer-to-Peer lending works in a very similar way. But, instead of songs you’re using money.

Why would anyone lend money to another person? What’s the catch?

Interest. If you go to a bank and ask for a loan, assuming you’re approved, you’ll get an interest rate attached to that loan. In Peer-to-Peer lending the bank is removed from the equation and replaced with other peers that we call investors. These investors are willing to lend people their money and as a return they’ll get the principle (the original loan amount) and the interest back. Since the bank is removed the investor gets all the proceeds.

Who needs these loans?

A lot of people have multiple credit cards and want to pay them off and consolidate their debt with one monthly payment. For example, if John Smith has four credit cards and he’s getting behind on payments, he may end up paying about 15% on interest trying to catch up. If John takes out a loan large enough to pay off all four credit cards, not only will he have one payment, but the interest on that loan may be half the percent of the credit card interest. Other people cannot get approved for a variety of loans such as an auto loan, new business loan, home improvement, or even a home mortgage due to too many pre-existing loans, lower income, or lower credit score.

What if they don’t pay?

Not everyone will pay and that’s definitely a risk an investor will have to take. However, each Peer-to-Peer vendor does their best to contact the person with the loan within the grace period to ensure they’re going to pay. They’ll even go as far to attempt to readjust the length of the loan, work out a payment plan, and if worse comes to worse, they’ll work with a collection agency. From my experience, if they’re still unable to pay at this point then they’ve declared bankruptcy and declared economically unfeasible to recover. This is a huge deal and can destroy your credit score, so most people avoid this as much as possible.

How often does this happen?

Rarely. It’s considered a Charge Off at this point. As of this writing, I have over 500 notes (loans) and only 20 have been charged off. To relieve your anxiety further, these 20 had a total value of $302.84 when they were loaned. $164.55 was paid back before they were charged off.

 What about the other 480 notes?

  • 19 aren’t issued
  • 365 are current
  • 5 are in a 15-day grace period
  • 0 are 16-30 day delayed
  • 8 are 31-120 days delayed, and will probably be charged off

 Okay, so 8 charged off, and 5 down the line might be bad. Why risk it?

Focusing on the negative aspect still? For these 8 notes, $140.64 was the principle amount, and I’ve recovered $90.91 of that. That’s about 64% of the funds recovered. So let’s look at everything on a whole level: I’ve invested $9,000 dollars. Keep in mind, only $8,000 was invested less than 6 months ago. To this day, I’ve received $1,320.06 in interest alone. Total payments with interest is $6,459.56. This puts me at about 8.35% interest per year. Let that sink in.

How do I minimize risk?

One solution is not putting all your eggs in one basket. I will give notes out in the amount of $25 – $50 each. Other investors may use different amounts to fulfill the full loan amount.

Thankfully, a lot of these vendors provide open API (Application Protocol Interface). What this means is that it is essentially a library with books where people can go in and read the book. After they read the book, they will be able to tell other people about the book and even refer to it. API is the book in this context, and the people telling the stories are developers. Developers have the ability to use the API and produce interesting results. So, why should you care about API? Developers will take all the statistical data from these lending sites and provide information. Take a look atlendstats.com. You will notice that with the API provided by Lending Club and Prosper can provide interesting statistics like who the top lenders are.

It gets better. Nickel Steamroller is a site that lets you determine what kind of interest rate you can expect given certain filters. For example, you can see that people with an income less than $30,000 will have more than a 8% loss rate, or how many will be charged off. People with 0 credit inquiries have a loss 4.63% as opposed to people with greater than 3 inquiries have 10.64%.

One thing to take in account, though, is that the lower loss you’re willing to take will typically equal to less of an interest rate. It helps to balance out your account where you have some risky investments, and some conservative investments.

Who are these vendors?

There are several, but the two largest are Lending Club andProsper. Go ahead and give it a try.

Update (4/28/2016):

As of April, 2016, I have spent over a year testing algorithms using these websites above and developed my own system that takes advantage of Lending Club’s API. The system is called Flux Robot and is available for anyone to sign up. Below is a screenshot of my portfolio using the exact same algorithm available from the site as of 4/28/2016.

Screenshot 4 28 2016 3 56 23 PM 002