Prosper Review – Should You Take the Social Lending Plunge?

When you consider any financial transaction, it’s always good to start out with a negative bias. In other words, it’s good to actively look for problems and search for what might go wrong before you sign on the bottom line. I always assume the worst and look for landmines. If I don’t find anything, I rest easy. My Prosper review is no different. Let’s get started.

What is Prosper?

Prosper.com is a peer to peer lending company. It isn’t a bank but more like a match maker. They take individual people who want to invest and put them together with people who need to borrow money. They have over 1.66 million members and service $474,000,000 in loans. The loans range from $2,000 to $25,000 for 1, 3 or 5 years. The loans are fully amortized too – they are not interest only loans. Also, loans can be paid off early (fully or partially) without any pre-payment penalty.

Prosper was actually the very first peer-to-peer lending company. Countless numbers of borrowers have used Proper to save millions in interest and as just as many people have earned multiples of what they otherwise could in the bank. (But be cautious – investing in Prosper in not like investing in the bank. More on that later.)

The screen shot below is from their homepage. You can see that it’s appealing both for investors and for borrowers.

How does Prosper work?

It’s a three-step process:

1. Borrowers sign up for free at Prosper and list the amount they want to borrow.
2. Investors review loans that are available and select those that meet their own personal criteria.
3. Once loans are funded, borrowers make monthly payments that are deposited into the investors’ account.

Why would anyone borrow money this way?

There are two kinds of borrowers that come to Prosper to fund their loans. The first group wants to pay a lower interest rate than they currently pay. For example, if you have a high-interest credit card debt you might use Prosper to find lenders who are willing to loan you the money at a much lower rate. That would save you a ton of money.

The second group of people simply have no other source of funding and come to Prosper as a last resort. Lets say you want to start a new business, pay off some bills or buy a new home. If you can’t find a institution willing to loan you the money, that’s where Prosper steps in. They help find you people who are not only willing to lend you money, they are eager to do so.

Why would anyone invest this way?

People are attracted Prosper because they are looking for higher rates than they can earn elsewhere. Lenders can invest a very small amount in many loans or concentrate more capital in a small number of loans. The choice is up to each investor.  Still, there are risks.

What are the risks of using Prosper?

There are two risks for investors. First, you take the risk that the borrower may default. If they do, you are pretty much out to lunch because the loans are unsecured. That means you have no collateral whatsoever. Prosper suggests that you can reduce your risk in a variety of ways.

First only make loans to high quality borrowers. Prosper rates each borrower based on their credit score and credit history. The lower the score, the higher the interest rate charged but the greater the risk. If you want to reduce your risks as an investor, make loans to higher rated borrowers. If you want higher returns and are willing to take a chance, put some money with higher risk borrowers. You can also do a little of both to blend higher security with higher returns.

The best way to reduce your risk is to have many loans. When I spoke with the folks at Prosper they told me that the happiest investors are those who invest in at least 100 loans. Since the minimum investment is $25 per loan, you would want to start with $2500 (at least) to spread your money out sufficiently.  Still, that is no guarantee.  Remember, these are unsecured loans to people who have probably been turned down elsewhere.

What if the borrower defaults?

If the borrower defaults you may lose your money. That’s why I don’t endorse this investment.  But if you still want to invest this way you should probably make lots of small investments in many loans rather than concentrate your capital in just a few loans.

Prosper uses a collection agency for any loan that is more than 30 days late and you might get some of your money back this way but don’t count on it. That’s because the people who are delinquent probably aren’t going to cough up what they owe you. Also, the collection agency will take a nice bite out of whatever they do collect – between 15% and 30%. You are much better off by having lots of little loans and investing in higher-quality borrowers in my opinion – or investing some other way.

Prosper has also taken steps to help investors reduce losses and they’ve taken great strides to improve investors’ performance. When they first opened their doors, they didn’t scrutinize borrowers as well as they should have.Take a look at the chart below. This shows performance from 2005 through 2009 and indicates that if you made any loans other than those rated AA through B you would have lost money because of defaults.

But Prosper regrouped and really tightened up their underwriting since 2009. Look at the newer performance numbers below:

These numbers look a lot better. It indicates that defaults are still there but nothing like they used to be. In fact, every single loan rating class was profitable even after the defaults. That is fantastic. It looks Prosper is doing a great job at underwriting loans. That means they are finding borrowers that repay their loans for the most part.  Of course, that’s no guarantee and things could change for the worse at any time.

The site also allows you to read up on the borrower to see who you are doing business with. You can review their credit rating and a great deal more. You see how the borrower intends to use the money and the total amount the person wants to borrow. You can even ask the borrower questions and see his or her responses to questions other potential lenders have asked.

How are borrowers rated and what are the rates they pay?

Prosper runs a credit report and gets the credit history for every potential borrower. Then, they ask more questions in order to arrive at a rating. Every borrower is assigned to one of 8 categories:

• AA
• A
• B
• C
• D
• E
• HR

Based on the rating that Prosper assigns, the borrower pays a stated interest rate and that rate is fixed for the duration of the loan. The higher the rating the lower the interest charged. Your rate will also be influenced by how long you want the money for and whether or not you’ve been financed by Prosper before. Here is a current rate sheet (subject to change) for AA borrowers:

You can see that the rate goes down as the length of the loan decreases. If you want the money for a long time, you’ll pay higher rates. This seems logical to me.

What are the risks for borrowers?

I can’t think of any. If you are already paying a high interest rate, what harm can there be in trying to get a lower rate? It only takes a few minutes to set up your listing. The worst case is that no lenders will fund you. In that case, you are no worse off than you were before you started the procedure.

I suppose the one down side could be that you might borrow money that you really shouldn’t. In other words, if all the banks have turned you down, maybe they know something you don’t. It might be the universe’s way of telling you to walk away and do something else. Prosper might facilitate you getting a loan that you really should not take. While I don’t believe this is a huge problem, it is certainly a question borrowers should ask themselves before they take the money.

What does Prosper get out of this?

Prosper isn’t doing this for their health. They charge investors 1% of the loan balance every year. In other words, the borrower might be paying 8% but the investor will get 7%. There are also loan origination fees the borrower must pay if the loan is actually funded. In addition, if the borrower is late on making payments Prosper will charge the borrower $15 which they keep.

How do investors get started with Prosper?

Getting set up takes about 5 minutes. You sign up for Prosper and attach your bank account to your Prosper account so you can transfer money back and forth. While it will only take you 5 minutes to set it up, it will actually take a few days before you can actually invest.

That’s because Prosper makes a small token deposit and withdrawal into and out of your bank account. Then, you verify the transactions. This is done to ensure you really are who you say you are. I like it. From that point on, you simply transfer money into your Prosper account, decide which loans to invest in and start collecting those juicy interest checks.

You select your loans based on the amount of risk you are willing to take and the length of time you are willing to invest for. You can either select specific loans that you like or use an automated system called “quick invest” do the work for you.

The above shows the “browse listings” screen. You can see a variety of options and the ratings too. Also, you can see the status of the verification process as shown. This indicates how far along Prosper is in verifying all the borrower’s information. The loans that are further along this verification process are more attractive because they have a higher likelihood of being funded.

Loan payments will automatically be deducted from the borrowers account and deposited into your Prosper account. You can then either have that money automatically deposited into your bank account or you can invest it in other loans.

What happens if an investor wants to cash out before the loan is repaid?

This is where Prosper shines. Unlike other peer-to-peer lending companies, there is a liquid secondary market for Prosper loans. That’s pretty nifty. You can sell your loan on Folio Investing any time you like. Keep in mind that depending on market conditions you may get more or less than you originally invested. Folio also charges 1% of the face amount of the loan as a transaction fee.

Who can invest?

If you are 18 years old and are a resident of one of the states below and you have a valid social security number, you can invest:

Alaska, California, Colorado, Connecticut, Delaware, District of Columbia, Florida, Georgia, Hawaii, Idaho, Illinois, Louisiana, Maine, Minnesota, Mississippi, Missouri, Montana, Nevada, New Hampshire, New York,Oregon, Rhode Island, South Carolina, South Dakota, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin and Wyoming.

If you live in Idaho, New Hampshire, Oregon, Virginia, Washington, Maine or California you can invest but you must meet certain requirements. They aren’t that difficult to overcome but you must be aware of them.

Who can borrow money?

Residents of Iowa, Maine and North Dakota are out of luck – Prosper won’t help you get a loan. All other residents of the United States are able to borrow with Prosper.

You will need a Experian Scorex Plus score of at least 640. Once you apply, Prosper will check your credit score. You must have a bank account and a Social Security number. Keep in mind that the loans can be as little as $2000 and as great as $25,000 (but no more).

If you want a rate quote, you’ll have to complete an application. That means you’ll have to supply your social security number. Prosper says that this process isn’t considered a hard inquiry on your credit report. As a result, it won’t count negatively on your credit history.

What does it cost to get a loan?

You pay nothing to list your loan. Once your loan is funded you’ll be charged a closing fee according to the following schedule:

How do borrowers get set up?

Step 1 – Create a loan listing.

Prosper did a good job making this very easy to do. It’s simple and takes less than 5 minutes. Borrowers go to the site and sign up. There, they answer a few questions to see how Prosper can get you the best rate and the best terms. Then they check your identity and get your credit score. According to the site, this doesn’t impact your credit since it isn’t a hard inquiry.

This is the point where Prosper assigns a rating. The rating determines the interest rate you’ll be charged. Up until this point, you still haven’t paid a dime in fees. I like that as well.

Step 2 Investors commit to fund your loan

Once you’ve completed step 1, your loan listing goes live on Prosper’s site. Investors see your listing and if it’s a fit, they’ll commit to fund some or all of your loan. You can watch this process as it unfolds. The loan stays live until it’s either fully funded or for 14 days. If you haven’t received commitments for at least 70% of the amount by 14 days, the loan is taken down and you don’t get a loan. Of course you can try again by simply creating a new listing.

Step 3 Receive Your Money and Then Start To Make Your Payments

Once your loan is funded you’ll start making the agreed upon payments. The payment will be automatically deducted from your bank account. You can pay the loan off early if you like. There are no hidden fees or prepayment penalties. The interest will never change either. These are all points I really appreciate and respect.

What about late fees?

If your payment fails, you’ll pay a $15 penalty. That goes for failed automatic withdrawals, returned checks or bank drafts. Prosper keeps that penalty money.

What is the best way for a borrower to get fully funded and funded quickly?

There are a number of things borrowers can do.

• Amount – Prosper reports that smaller loans get funded faster than larger loans.
• Help Prosper during the verification process – Once you begin the process your loan will be listed and made available to investors. But during the funding phase there is a parallel verification phase where Prosper will ask you for supporting documents to prove your identity, income and employment status. The sooner you return those documents to Prosper the better. That’s because Lenders like to commit funds to loans that are going to happen. They don’t want to tie up their money for a few weeks only to learn that the loan isn’t going to be funded. This verification process is shown real-time on the site so make sure to help Prosper advance your process as much as possible.
• Advertise – Prosper has Facebook and Twitter buttons on their site. Use them to advertise your loan to your Facebook and Twitter followers. While you’re at it, tell your friends and family about what you are doing. They may want a piece of the action. The faster you get a high percentage of your loan funded the more likely it will be that you’ll get all the funding you asked for.

Make sure to check your spelling and grammar on your listing. If you demonstrate sloppiness in your application lenders will assume you’ll be sloppy about repaying them as well. Don’t open that door.

Bottom Line – What I like About Prosper

1. Transparency – I loved the fact that Prosper’s site had all the data – good or bad – and it was easy to find. I like that they clearly point out the risks with respect to defaults.
2. Improvement – In 2008 the SEC shut down all the peer to peer lending companies. They decided that these loans were securities and as such the companies selling the securities had to register as such. Only two such companies did so – Lending Club and Prosper. Prosper came out of the process very strong. They vastly enhanced their ability to screen out dead-beat borrowers (but they couldn’t eliminate that of course.) You can see that before the SEC took action, the only people making money were those making the highest quality loans. But since they emerged and registered with the SEC, almost all the loan categories are performing. That means Prosper is experiencing far fewer defaults. Nobody can say if that trend will continue but it’s a big step in the right direction.
3. Contingency Planning – While the business is growing you just never know. I asked Prosper what would happen to investors if the company went out of business. They told me they have an arrangement with a third-party to continue servicing loans if that were to take place.
4. Strength – Prosper doubled their business in 2012. That’s impressive. Also, they recently accepted a $20 million dollar investment into the firm itself. The money came from Sequoia Capital. These are the folks who worked with Steve Jobs at Apple, Larry Ellison of Oracle, Jerry Yang at Yahoo!, Larry Page of Google etc etc. They are very serious investors and know how to do their homework. I believe that’s a good sign too. In December of 2012 investors brought them $10 million in new assets. That shows solid growth.
5. Easy to use – I like that the site is easy to use for both borrowers and investors. I like the “quick invest” feature to help investors locate the loans that meet their needs.

My concerns about Prosper

As a borrower, I have no concerns what-so-ever. If you need money and can get it cheaper from Prosper there is no reason why you wouldn’t do so. For investors, I might tread with caution. I don’t have any real concerns about the integrity of the people who run the company. I was very impressed with this. I have just two worries.

I guess I am old fashioned. I don’t like the idea of lending money to people I don’t know (I actually don’t like lending money to anyone.) And I certainly don’t like making unsecured loans. That isn’t a criticism with Prosper but with the idea of the industry. To be fair, Prosper has really done an amazing job of tightening up their underwriting. Their loan losses seem acceptable now. While they used to make loans to people with lower credit scores, they no longer extend any loans to those without at least a 640 credit score. This alone has really helped them. So this may be an emotional hesitation rather than one based on reality.  Still, all this could take a turn south at any time and that’s another reason why I do not recommend you invest with Prosper or any peer-to-peer lender.

The other concern I have is about an old class action suit which has not been settled. Given the fact that some institutional investors recently bought some of the privately held stock to the tune of $26 million, I would think that the law suit is not a major obstacle to the viability of the company but I don’t know that to be the case.

I suppose it’s difficult to find any large company that isn’t being sued by somebody and to be frank, it’s not my major concern. If I were to invest in a company like this it would be with a small amount of money at first. And I would only do so if I had at least $2500 to get the minimum 100 loans I feel are needed. I would do that for a year and learn more. I would see what the experience was like – and I’d also hope for more clarity on the litigation.

*Before investing with Prosper, be sure to read their prospectus.

** Disclaimer Please be advised that I am an affiliate of Prosper and will make money if you open an account with them. That means Prosper pays me when people borrow or invest using their system who came from my site.

The information and opinions contained in this presentation are provided by Neal Frankle and Wealth Pilgrim are for informational purposes only and are subject to change without notice. The information contained herein is qualified in its entirety by the more detailed information contained in the offering prospectus (the Prospectus) available from the issuer. Neal Frankle and/or Wealth Pilgrim are not soliciting any action based upon it. The content of this presentation is based upon information that we consider reliable, but neither Neal Frankle, Wealth Pilgrim nor any of its managers or employees represents that it is accurate or complete, and it should not be relied upon as such. An investment in the Borrower Dependent Notes involves significant investment considerations and risks which are described in the Prospectus. Nothing contained herein constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment decision.