Escape from Prosper

I joined Prosper.com (a sponsor of this site) in May, 2006. This was about a week before I became a parent and about the same time Osama was moving into his new home. I say this because I would love to blame my joining on pregnancy brain or some terrorist plot. However, as in so many cases, I have only myself to blame. I have to admit I was really excited about Prosper when I first started. It gave me as an individual the opportunity to bid on all sorts of personal loans based on the touching stories detailing their reasoning behind their loan needs as well as what appeared to be reasonable pieces of financial history and credit worthiness vetted by the professionals over at Prosper headquarters. How beautiful! I get to help those less fortunate while earning an excellent return!  How naive…

These were the Wild West days at Prosper where you could actually bid down the rate of loans so that better borrowers (or liars) could get a better rate.  You could also post openly in the Prosper  forums and even interact with potential borrowers (so they could lie to you some more).  It was a slippery slope and lenders were greedy, bidding down HR (high risk) loans but still getting incredible rates 25%+.  And, for the first couple of months it almost always looked good.  The borrowers would pay, and I couldn't wait to accrue enough payments to start funding my next loan.  In the beginning, I was smart enough to diversify my risk across a basket of loans, only investing $50 in any single loan.  Later, I was even smarter and threw all of my money into 1 loan.  More on that later.  

The problems started to creep in around 3-6 months into your loaning.  Loans that were paying stopped paying on time.  Then, they just stopped paying.  It turns out the risk estimates in the early days were FAR too conservative.  Actual loan default rates were exploding.  

Prosper was unprepared for this, and so were the now incensed lenders.  The problem for the lenders though was that Prosper had become popularized in the media and people were piling on to get these extraordinary returns, but these new lenders didn't know the risk.  So, instead of lenders demanding greater interest rates for greater risk, the loans were getting bid down lower and lower because the number of lenders so outnumbered the number of borrowers.  Additionally, around this time, some borrower must've figured out that Prosper's collection process was in disarray and spread the word because a new kind of borrower showed up making multiple loan requests with no intention of ever paying.  Some sharp-eyed lenders began spotting these guys and reporting them to Prosper, but the process was slow and oftentimes loans like these fully funded before anything could be done.  Lots of people lost $ this way.

My own story is slightly different.  I was certainly greedy at first and took on much more risk than I was thinking.  Of the 22 loans I made in 2006, 9 (41%) defaulted.  It's hard to make money at a 41% default rate.  By 2007 and 2008 I had a much better system in place to gauge risk and Prosper itself was beginning to make improvements.  Of the 21 loans I made during that period, only 3 defaulted (15%).  This is still not very good, but as I mentioned earlier, I stopped diversifying.  In mid-2008 a close friend went through a divorce that left him saddled with a lot of credit card debt.  I mentioned Prosper as a possible solution to consolidate the debt and get a fixed rate.  He jumped at the chance.  Knowing he was a low risk relative to his credit history, I jumped at the chance to fund his loan.  I not only used all my remaining Prosper funds, but I also added as much as I could from my play accounts.  This loan alone made up over 50% of my portfolio.  The interest rate?  14%.  As expected, my friend kept his word.  His loan paid off a couple of weeks ago, and it made all the difference fiscally speaking in my Prosper experience.  Overall, my return outpaced the S&P 500 over the same time period.  Barely.  Many others have been less fortunate.

So, how do I feel about Prosper today?  Well, I can't participate in Prosper right now because I live in one of the states where Prosper is unavailable.  If I could, I would only dabble with a small portion of my play money because I have questions about the sustainability of the Prosper business model in the long term and because doing my taxes is a much larger pain in the ass thanks to the dearth of information from Prosper and the IRS about how to do it properly.  For anyone interested in Prosper, feel free to use the link at the top of this article but also be sure to check out the forums at Prospers.org for a highly informed opinion from seasoned lenders.

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  • dwayne

    So a Prosper bubble? That sounds like an NPR Planet Money podcast topic.