Surprise! Peer to Peer Lending is Risky

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Earlier this week, Mark Gimein wrote a great article on detailing, statistically, how risky person-to-person lending really is. I’ve always known it to be peer to peer lending or social lending, but the article calls out the riskiness of, the first and one of the largest of the peer lending networks.

To look at the results of Prosper’s loan marketplace, though, is to see not a solution to the credit crisis, but a microcosm of it. Loans to unqualified borrowers; reliance on mathematical models that turn out to be a lot less useful than they seemed; failed hopes that high interest rates could make subprime loans profitable; sky high default rates—Prosper has it all. Prosper’s Web site advertises returns of 6 percent to 14 percent for lenders. But the reality is that the lenders who loaned $188 million through Prosper have not earned anything like these returns. On the contrary, the majority of them have lost money, as they’ve watched their loans go bad at shockingly high rates.

The takeaway from the article isn’t that you should avoid Prosper, it’s that you probably should avoid peer to peer lending entirely. (In fact, I think Prosper should be lauded for making their loan data public!) There simply wasn’t, and likely isn’t, enough information for you to adequately price in the risk of default. Are things better today than they were in 2007? Probably, but the reality is the peer to peer lending marketplace is a lot riskier than you think.

Whenever there’s something new like this, there’s a subset of its users who will find a way to benefit. For the longest time, the early adopters thought they were the ones who benefited. Unfortunately, as it turns out, the true beneficiaries were the social lending networks (who take a percentage of the loan in fees) and the borrowers themselves (who received loans they probably wouldn’t have qualified for).

When I tweeted this article out, @PotatoPeeler said – “Do we need a whole article to tell us that lending money to random people on the internet is an absolutely horrible idea?” I wholeheartedly agree!

I know people who have been lucky enough to avoid the default plague so far and it seems as though it’s only a matter of time. A little bit of me is now glad that Maryland residents aren’t permitted to “invest” in these loans.

(Photo: nitrofive)

{ 42 comments, please add your thoughts now! }

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42 Responses to “Surprise! Peer to Peer Lending is Risky”

  1. Definitely risky. I don’t think anybody has more than $5,000 with these places… and less than that, what’s the point?

  2. molotri says:

    I have 19 loans in prosper, no defaults yet. My strategy is to lend to people with a grade of B or better, amounts lower than 5000 and a nice rate of course!

  3. John Smith says:

    Jim seems a mite prejudiced against p2P lending for some reason. I love the comment “lending money to random people on the internet is an absolutely horrible idea”, which sums up the attitude quite well.

    I’m not sure how lending money to people over the web differs from any other type of unsecured lending. Lenders look at the same information – credit score, job, pay, debt to income ratio. It’s the quality of underwriting that counts – how fussy you are about borrowers and how carefully the information they give you is checked. Doesn’t matter if it’s over the web, telephone or in person at the local bank. It seems to me that Prosper dropped the ball in the underwriting department. LendingClub looks considerably better, IMHO. But time will tell. There’s no problem with P2P, but there may be a problem with how well it has been executed so far (and let’s face we have only had a couple of companies with limited lending experience try this).

    • Jim says:

      I don’t like p2p lending but I don’t think it’s based on “prejudice.” I just think it’s a bad idea. I also don’t lend money to strangers.

  4. Anon says:

    Hello Jim, this article that you qouted says that they dont think lenders have seen anything like the returns they advertise. This sounds like a baseless claim. Are you simply saying they are lying about lenders return on investment? I understand P2P is risky but to categorically say its a losing bet for lenders seems a bit baseless. Do you have some facts/statistics to back this claim?

  5. greg says:

    Glad it isn’t availed in MD. Really? You can gamble in MD, poor hundreds of dollars into a slot and press a button hoping for a return. At least with P2p I can do some amount of research and evaluate my own risk tolerance.

    Tell you what, I can regulate my use of my money much better than the state of Maryland.

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