What facts? The fact is that p2p lending has not been around long enough to properly analyze the data so I really don’t know what facts or homework you are talking about.

As for the ability to make 12% with only 1-2% defaults – This is not guaranteed over an entire business cycle. Sub prime loans are a great example of a high interest rate lending plan which worked extremely well for a long time but when times got rough – they got really rough.

High interest loans have a higher risk factor not unlike stocks so you have to be able to handle the ups and downs. Over the long run (ie 10-15 years or more) hopefully the high interest lending will have a good return but there is no guarantee – similar to investing in equities.

Mike

and it is actually the reverse..the higher the risk factor the higher the interest rate…not visa-versa

The higher the interest rate, the higher the risk factor – it’s as simple as that.

As I said in the post – I’m not at all against P2P lending. If it fits your investment plan then it’s a good tool, but like any investment it’s important to understand what you are dealing with.

Mike

You know why I like P2P lending? Because it’s one of the first steps to freeing the flow of capital via corporate entities in America. I like it because it’s a fresh idea, it’s somewhere to put my money besides the bloated stock market, and it’s just plain and simply interesting to work with. Would I invest more than 2%-3% of my investment portfolio there? No way. I feel that it’s a good niche investment. I’m not going to retire off of it, but I’ll certainly keep a toe in the water.

In the case of your friend, you have to keep in mind that not everyone knows him as well as you do, so your typical lender has to look at the various ratios/scores etc and make a decision based on that. It’s not perfect as your friend proved but that’s the way it is. I would think that a P2P lender would be more willing to lend money to someone who is in the situation your friend was in (at a high rate) but there is no guarantee.

Mike

One of the big risks that I would be concerned about is if interest rates go up. Presumably people who borrow on p2p are people who can’t get the loan from a bank at a normal rate – I would assume these people have already maxed out their credit or at a minimum have a lot of debt which makes them very vulnerable if interest rates increase.

In my example we are looking at someone who has a lot of credit card debt at a high interest rate (30%). Since they can’t consolidate their CC debt into a more reasonable loan they are stuck in a bad situation that is not solvable in the standard banking market. And given the availability of p2p options that would be able to reduce that interest rate significantly and buffer him from rate hikes, and as such the lenders would reap a high rate of return.

1. The banks are far better at analyzing debtor risk than you or I (too bad they couldn’t analyze subprime securitization loans) so if they don’t feel the person is worth the risk at 10% then you are not getting a deal – you are getting a high risk loan.
2. If the person seems to have reasonable credit then they might have maxed out all their available credit which implies to me that their credit score is meaningless in that situation.

Actually, banks are only better at it when you fall into the standard categories, which is why they don’t lend to you if you don’t fall into their model. Once the borrower falls outside those norms (like my example) the current banking system doesn’t even try to provide an option. If they were trying to fill this gap they would probably be better at it, but since they aren’t there is money to be made.

As a lender on Prosper if you want to set up some kind of automatic system where you lend to people based on certain criteria I think you are absolutely right and the risk is higher than the rewards, but if you put in the time to pick borrowers whose situations put them outside the standard borrowing options, but are still quality borrowers, you could make a lot of money and that is the whole point of being a lender.

David – you are correct in that you don’t know what the borrower is going to do with the money. Diversification is indeed the key.

Mike – I never said the risk are well understood – quite the contrary, I think the defaults rates are understated.

sucellus – I’m not sure how your friend’s example is relevant to an analysis of P2P lending from the point of view of an investor. I would agree that your friend would probably have benefited from being able to use P2P had it been available at the time.

Mike

A friend of mine went through a really tough year where he lost his job and racked up a large amount of credit card debt. He was single, living on his own, and with no help from outside sources (parents, etc.). In addition, he had a problem with the university he had attended where they were claiming he still owed them money (he didn’t) and they reported the problems to the credit bureaus. He eventually got a new job and had been paying all his bills regularly, but because of the large amount of debt, the short term problems paying bills, no home to be used for equity, and the issues regarding his credit score he was unable to get a traditional loan. He was eventually able to get out of debt after a couple of years by doing some complicated juggling where he paid off a single card, negotiated a lower rate with that card and started doing transfers to that card. It took him years to pay off his debt; he could have easily paid it off if he had been able to get a reasonable interest rate. He would have gladly paid even 15% as opposed to the 30% he was paying to the credit cards.

2. If the person seems to have reasonable credit then they might have maxed out all their available credit which implies to me that their credit score is meaningless in that situation.”

I don’t think a borrower’s credit score is meaningless IF they are looking for a lower-interest loan to repay the debts that have them maxed out. It never looks good when somebody is maxed out, but I would guess somebody who is maxed out with a 700 credit score makes good on those debts far more often than somebody with a 500 credit score.

Of course, there is no way to guarantee that is how they will use the loan, or that they won’t abuse the credit freed up by the P2P loan. This is why banks won’t lend more money in this case.

But I think P2P offers an important third option for people trying to get out of debt (instead of bankruptcy or debt management), and it relies on lenders to provide that.

The lack of tax benefits and risks are all something that should go into a lender’s plan for the interest rates they will accept. And, like all investing, I would never invest in just one borrower — I would loan small amounts, $25 or $50 each, to dozens or hundreds of borrowers at different risk levels.

Mike