Credit 
12
comments

Peer to Peer Lending Becoming More Popular

I was listening to NPR’s Morning Edition the other day when they started talking about peer-to-peer lending companies like Lending Club and Prosper (currently closed pending SEC approval).

I’ve written about peer to peer lending a few times before, first when Prosper’s Peer to Peer Lending Marketing debuted and then once again when LendingClub offered their peer to peer lending service.

I personally don’t invest using either service because I didn’t have confidence in an untested system in a totally new paradigm. However, if I were a borrower, I’d jump at the chance to borrow money from individuals rather than the monolithic lending industry. You’d be kidding yourself if you didn’t think the lending industry, be it loans or credit cards, doesn’t jump at the chance to lock you in to something complicated and counterintuitive (option ARMs anyone?).

The borrowers probably benefit the most in this arrangement. The experiences profiled in the Morning Edition clip echo many that I’ve read online – borrowers get the opportunity to get loans with better terms and with less headache. While you are still ranked by your score, you get to add a little color commentary not captured in credit histories.

For investors, I have read that default rates were higher than they first listed and individuals are finally learning why the lending industry acts the way it does. A lot of people default. The benefit of peer to peer lending is that investors can invest small amounts into many loans, thus diversifying their risk. I like the idea of having another avenue to invest in outside the typical stock/bond/whatever paradigm but I’m still apprehensive.

While I’m still not sold on the idea of investing in peer to peer marketplaces, if I needed a loan I wouldn’t hesitate to put them on my list of places to get a quote from. What are your thoughts on the peer to peer lending industry?


 Banking 
5
comments

Avoid These Three “Short-Term” Loans

Payday Loan StorefrontIn an ideal world, when you needed to borrow some money, you could just walk into your bank and just ask. However, banks are funny in that they generally are willing to give you money when you don’t need it but are less forthcoming when you actually need it. In these harder economic times, those in need of money may be tempted to turn towards other “financial institutions” for short term loans and I’m here to try to dissuade you. These are horrible short-term loans with horrible terms (and their high probability of becoming extremely expensive long term loans) and should be your last resort if you’re in need of cash.

“Refund Anticipation Loans”

These are loans offered by tax preparation firms based on your tax return. They offer them because they know exactly how much of a return you’ll be getting, when you’ll be getting it, and how much money they’ll be making by lending you that money a few weeks early. They’re expensive loans, despite how safe they are, and they’re packed with tons of fees. The industry earned over a billion dollars in 2006, I wonder how many of those dollars were earned from folks who didn’t know they were getting a loan in the first place? Probably more than you’d think.

Payday Loans

Need a few extra bucks to make it through to your next paycheck? How about a little extra scratch so you can get a gift that’s extra special? Payday loans typically have ridiculous high interest rates (think four digits and that’s not counting the decimal places) and their fees are atrocious. The scary part about payday loans is that most people only get one for a few hundred dollars so it doesn’t seem like all that much… then they get socked with fees and then something goes bad and then before you know it you’re going down the mountain with one ski and a prayer.

Credit Card Cash Advances

You might be tempted to stick your credit card into an ATM and simply withdraw some money but take heed. In addition to the interest you may pay by carrying that balance from month to month, cash advances are typically charged an additional fee based on the amount withdrawn. Most credit cards charge 3% of the advance and add that to the amount withdrawn. $100 becomes $103 and, if you carry that from month to month, can have a serious impact. A cash advance is not as bad as a RAL or a payday loan.

Better Sources of Short-Term Money

Need money for the short term? Here are some suggestions, in no particular order, that are better than Payday loans but not exactly ideal themselves:

  • Try the bank – you never know.
  • Cut other expenses so you’re spending less.
  • Ask your employer for your paycheck a little early.
  • Borrow from friends and family.
  • Consider peer-to-peer lending sites like LendingClub or Prosper.
  • Use your credit card for purchases and consider a card with 0% APY on purchases promotion. It’s not ideal but will give you more breathing room.
  • If you owe someone money, try to negotiate a deal. Delayed payment beats bankruptcy.

If you’re in good shape now but on the fringe, consider cutting some expenses so you can bolster up the emergency fund. It’s far easier to get money out of a bank account than it is to get it from anywhere else.

Anyone else have any ideas?

(Photo: andrewbain)


 Personal Finance 
3
comments

The Smartest Financial Advice Ever

CNNMoney.com asked forty famous people for their best piece of financial advice. You’ll hear answers from the likes of Bill Miller, Derek Jeter, Jon Barry, Steven Levitt, and even advice from Rodney Dangerfield. In the beginning of the slideshow, the photos are of the respondents but as you get closer to the end it’s photos of the origins of the advice; you’ll know what I mean when you get there.

Unfortunately, they didn’t ask me, otherwise this is what I’d say about the smartest financial advice I got:

The smartest advice I ever got from my parents was to always work hard. My dad once told me that I was one of those people who could complete a fifteen minute job in ten minutes. As I basked in the compliment, my dad told me that what would separate me from the other people who could do the same thing was what I did with the other five minutes. Everyone has talent in something, but not everyone has a work ethic. A strong worth ethic is what separates the great from the merely good. I can’t say I disagree.

Here are my favorites from the slideshow:

Elizabeth Gilbert: Swear off debt.

Elizabeth Gilbert is the author of Eat, Pray, Love, a book my wife has read and really enjoyed, and I thought this bit of advice from her parents was a gem. Her father passed along this message from her grandfather: “Borrowing money is like wetting your bed in the middle of the night. At first all you feel is warmth and release. But very, very quickly comes the awful, cold discomfort of reality.”

In Taiwan, and China, the concept of consumer debt is only a recent phenomenon. Until the last five or ten years, the idea of a credit card was foreign in Taiwan. My father told us a story about when my parents bought a home on Long Island that my grandfather wanted to give him the cost of the home (this was nearly thirty years ago). My dad explained to my grandfather that he could put 20% down and borrow the rest, a concept that made no sense to his grandfather. Why borrow money? Just keep saving and saving and saving until you can afford it. It’s amazing how pervasive consumer credit has become in such a short time.

Derek Jeter: Know where your money goes.

Derek Jeter is the shortstop for the New York Yankees and considering the size of his paycheck, it’s amazing this was the advice he thought of. I think it’s valuable because as we get older, the finances get more complex and you begin relying on more and more experts. We now have an accountant that handles our taxes, we leaned on a real estate agent when we bought our house, we’ll have to rely on the expertise of numerous subject matter experts as we grow older but it’s always important to be part of the process.

Chris Larsen: Take risks when you can.

Chris Larsen founded E-Loan.com and Prosper.com, two hugely successful and innovative companies in the lending industry. This bit of advice came from Jim Collins, author of Built to Last, Larsen’s MBA professor at Stanford. “You’re young. You can fail two or three times, even lose all your money two or three times, and you’ll be just fine. Taking that risk puts you in the path of wealth.”

In my MBA, I received similar advice from my Entrepreneurship professor. He said that, especially if you’re young, you should be willing to take risks and try paving your own way. It’ll be hard, you might fail, but the worst thing that can happen is that you go back and get another job.

There are a lot of good gems in there including appearances by Freakonomics author Steven Levitt, Four Hour Work Week author Tim Ferriss, and many many others.

The smartest advice I ever got [CNN Money]


 Investing 
15
comments

Why I Don’t Invest In Peer-To-Peer Lending

In the blogosphere there seems to be a lot of excitement about peer-to-peer lending which is the ability to lend money to other individuals through companies such as Prosper and Lending Club. While I can understand how some investors will always be interested in a new investment product I don’t really understand the widespread excitement and interest level for this one.

Some of the things people should think about when considering P2P lending:

Diversification

Lending to one person is kind of like investing in a very small risky stock such as a junior mining company or a startup biotech company. You really don’t know much about that borrower and if something happens to them such as a medical emergency then your loan to them might be at risk. You can mitigate this risk by lending using a portfolio plan but I suggest that while this does reduce your risk, it doesn’t change the basic asset class which is still quite risky. A portfolio of p2p loans is like a mutual fund with numerous junior mining companies). You reduce the risk of any one company failing but aren’t protected against events that affect all junior mining companies ie falling metal prices.

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.

Same as the old bank

Brip Blap wrote an interesting post on P2P which indicates that the lender “is the bank”. I have to disagree with this because I think Prosper or Lending Club is the bank. The only thing that really changes is that the p2p lender gets to choose who the borrower is which is not the case when you give money to a regular bank to get interest. Another issue I have is that Prosper and CL seem to be spending a lot of money to get clients – advertising, free money giveaways. Where does this money come from? As far as cutting out the middle man – P2P institutions charge for the loans so I don’t really see how they are very much different from banks.

Statistics

Another concern I have is that I think the interest rates are too good to be true. If a borrower is willing to take my money for 10% then I know that they couldn’t get that same loan at a bank. This is problematic for two reasons -

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.

The fact that p2p has not been around very long also means that any default rates are probably understated. A loan can go into default at any time in the three year term so looking at default rates before three years is not going to be very accurate. Also – with the default rates do they do it by time periods? ie years? if not then any new loans will decrease the default rate dramatically.

Taxation

In the US, interest income is treated as regular income for taxation purposes. Dividends and capital gains are given preferential treatment and you will pay less than than on interest. You will be better off taxation wise to have all three of those investment types in a tax-sheltered account such as a 401(k) or ROTH account. If however you have investments in a taxable account then ideally it should not be fixed income such as bonds or P2P loans. Since P2P loans are not eligible for tax sheltered accounts then the extra taxes will reduce returns significantly.

Asset allocation

Asset allocation or the type of assets you invest in (ie stocks, bonds, cash) is a critical step in the investment process. Personally I have 25% of my investments in fixed income and 75% in equities (stocks). Regardless of the expected rate of return, P2P lending is considered fixed income and it should fit into your desired asset allocation.

Basic economics

If something is too good to be true then it probably isn’t. Currently you can get approximately 4% interest on guaranteed certificates or accounts. If you invest in P2P loans and have an expected return of 10% then that puts you in a much higher risk level and there is a reasonable chance that you could lose 10% or more (much like equities).

Bottom line

I have no plans to invest in p2p loans anytime soon because they don’t fit my investment plan. I do want to make it clear that I’m not suggesting that p2p loans should be avoided or that they are a bad thing. If you know what you are investing in and it fits your investment objectives then go ahead and lend away!

This post comes from Mike of Quest for Four Pillars, “another Canadian Financial Blog,” that traces its namesake to none other than the Four Pillars of Investing by William Bernstein.


 Investing 
19
comments

Anyone Have Any Good Prosper.com Lender Stories?

It seems like everywhere I look online these days I see yet another Prosper lender lament about another late payment or default and how they can’t wait to dump the whole program all together. I mean seriously, who loves to lose money?

I took a look at Prosper, didn’t like what I saw, and never put my money in… and I’m glad I never did. That’s not to say that Prosper is bad for everyone, I just didn’t see any positives in it and I’m kind of glad I was conservative enough to hold back.

If you’re lending with Prosper and have good stories, please leave a comment! I’m sure some people are doing well with it, it just seems, from the blogging community, that there’s a lot of defaulting going on.


 Investing 
29
comments

Prosper People-to-People Lending Marketplace

I’ve seen a bunch of personal finance bloggers talk about Prosper lately and honestly I don’t see the sense in it. For those who aren’t familiar with it, it’s a place where you can loan money to other people and earn, in some cases, a hefty interest rate on it. Everyone seems to be approaching cautiously, with good reason since your money is not protected in any way, because the business model hasn’t been proven in the States yet (Zopa, something similar, exists in the UK) and most people don’t like the idea of lending real cash to complete strangers.

Handling Defaults:

For privacy reasons, we do not disclose the identity or contact information (like an email or telephone number) of members on the site for any reason. If you would like to contact the borrower yourself, you can go to that borrower’s member page, and click “Contact member.” Your message will be sent to the individual anonymously through the Prosper messaging system.

You can’t get into contact with the person you are lending to for “privacy reasons.” So when the borrower misses a monthly payment:

Once the loan is one month past due, it is turned over to a collection agency to pursue collection from the borrower. If the collection agency cannot collect payment from the borrower after a reasonable period of time (within 3 months), the loan will be considered uncollectable, and written off as a loss.

It’s written off in three months and then sold at auction, where you will receive the proceeds. “Because the debt is already fairly old by the time it reaches the debt buyer, you should not expect to receive much of your original investment in return for the outstanding debt.”

If you have very weak credit score, it wouldn’t be unreasonable for you to get a high risk loan, avoid the collection agency for a mere 3 months, then get your friend to bid on the loan and clear it – all for less than the auction price. That’s what I’d do if I was a scammer and wanted to rip people off.

Borrower Statistics:
Now add that with the experiences of Savvy Saver and you’re left with an empty feeling plus an empty wallet. Through very savvy 0% balance transfer offers, she has $40,000 of credit card debt and still receives a grade of A (second best!) by Prosper! Since credit grades and debt to income ratios are basically the two fundamental pieces of information about a Prosper borrower, you’ve just lost credibility in half of the equation. If you read further in her post, she notes that you can enter any income you want thus making the debt to income ratio metric an entirely useless one.

No real protection for lenders + Borrower stats weaker than eBay’s feedback system = I’m keeping my money in my mattress.


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