I'm curious what other FW'ers think of this idea which was featured in the NYT today. prosper.com allows you to make/receive small uncollaterialized loans with other individuals/small businesses. Basic credit information is provided and loans can be pooled for risk sharing (e.g. if someone wants to borrow $10k, 10 people could each put up $1k to avoid the catastrophic risk of default). Therfore, as a lender, you could have a diversified porfolio of multiple micro-loans.

In theory, I think this is a really neat idea - the use of the internet to reduce transactions costs and help broker deals between individuals. However, I'm not sure I'd be willing to put my money into it.

Established lenders (banks, CC companies, etc.) have pretty good models for estimating a customer's credit worthiness. Not to say that these models are perfect, but you have to admit that the professional organizations have a lot more experience, resources, and data to evaluate creditworthiness when compared to any individual lender (like your or me). The only credit score prosper provides on a creditor is a "grade" which covers a range of FICO scores. So from this point of view, the individual lender has no informational advantage over the big bank lender. If the debt market is fairly efficient, then it's going to be really hard for individuals to make loans at lower rates than the big players and still come out ahead once you subtract fees and the risk of default.

Of course, if an individual's cost of capital is significantly lower than the big lenders (which may or may not be true) then maybe there is room in the marketplace for this service. For example, I can earn 4.75% on my money at ING (at least for the next few months) which is virtually risk-free. How many more points will someone have to pay me to take on the added risk of lending to someone I don't know and taking payments over a 3 year term? Would a 2% premium be enough? 5%? Hard to say without getting very quantitative. Alternately, I could get 6.5% from a relatively high-quality junk-bond mutual fund...how does that risk compare to the risk of making Prosper loans?

I suppose you also have to consider that the big lenders have a relatively high fixed cost of making a loan (compared to the variable cost of funds as a % of the principal) just because of the time and paperwork involved - this is why most banks won't lend $500, because it's too hard to recoup the fixed costs on such a small amount. However, an individual may have a more advantageous cost structure.

For the small businesses on the site that are soliciting funds, I wonder if they are able to provide externally audited financial statements...I would be concerned about the risk of fraud.

I also wonder about what recourse lenders have against the borrowers if things go sour. Will Prosper.com hire collection agencies for large balances or do they just have to be written off? Prosper says that if you don't pay your debts on the site, they will ding your credit report...not sure if that is enough of a threat to encourage repayment.

Lastly, would an individual have to be concerned with any usury laws if he's making high-interest loans?

http://www.nytimes.com/2006/02/13/technology/13ecom.html

It's Like Lending to a Friend, Except You'll Get Interest

By BOB TEDESCHI

THE Internet has become a great place to track down friends — or friends of friends — for advice or for a date. Now you can ask them for money, too. Prosper.com, a start-up company based in San Francisco, started operations last week, offering a mixed brew of eBay, Friendster and the local bank.

Prosper's users lend money to and borrow money from other people on the site at what the company says are better interest rates than those available through traditional financial institutions and without some of the risk that comes from typical person-to-person loans.

"We looked at eBay and said, 'Why can't we do this for money?' " said Chris Larsen, Prosper's chief executive.

Mr. Larsen, who founded and led E-Loan, an online lender that was bought last year for $300 million by Popular Inc., says Prosper could save borrowers and lenders money because it was a leaner operation than traditional financial institutions. He noted that consumers make, at most, about 4 percent on their savings accounts, which banks then lend to credit card customers at 14 percent or more.

"That's just a huge spread," Mr. Larsen said. "We think if you allow people to participate directly, it's a more efficient marketplace. People can make a better return on their deposits, which then become the source of credit to others."

On Prosper.com, prospective borrowers register with the site and allow the company to review their credit history. Then borrowers post a loan request of up to $25,000, along with an upper limit for the amount of interest they are willing to pay. Loans are not secured by collateral and are paid off over three years at a fixed rate, with no prepayment penalty.

Lenders essentially deposit their money with Prosper — which holds it in an interest-bearing account with Wells Fargo— and either review the loan requests individually or fill out a form permitting Prosper to allocate money to borrowers who meet certain criteria.

Chief among those criteria is the borrower's rating from the credit reporting bureau Experian, but borrowers can also join or create groups with defined interests or characteristics that, they hope, will make them more attractive to some lenders.

Among the groups on Prosper are aficionados of the Porsche 914 model, associates and employees of a Berkeley cafe and Vietnamese-American students. Borrowers, who typically post their loan requests and any group affiliation, along with a description of who they are and why they need the money, then wait a maximum of two weeks for lenders to bid in ever-lower interest increments for the right to issue the loan.

To help lenders minimize risk, Prosper permits them to finance just part of a given loan, so a typical lender may offer, say, $100 at 6.5 percent interest toward a loan to someone with excellent credit.

Once the bidding is complete, and if enough lenders bid enough money to finance the loan at a single rate acceptable to the borrower, Prosper transfers the money to the borrower's account and establishes a monthly repayment system that withdraws money from the borrower's checking account. (Should a borrower default, Prosper hires a collection company on the lender's behalf and alerts credit bureaus.)

Prosper makes money by charging borrowers 1 percent of the loan amount, while lenders pay 0.5 percent of the loan's balance each year.

The community aspect of the site, Mr. Larsen said, is an important component. "It's satisfying to place money in little bits with people who have stories, and in groups that you know and trust and want to support," he said. "And if you're part of a group, the theory is that you'll perform better as a borrower than if it was some disconnected credit card company."

Some prominent venture capital firms, including Accel Partners and Benchmark Capital, have rallied around the idea. Jim Breyer, an Accel partner who serves on the board of Wal-Mart Stores, is a Prosper director, as is Bob Kagle, a general partner at Benchmark, who also serves on eBay's board.

Mr. Larsen said the site's two-month testing period went well, and as of last week, Prosper had attracted lenders with a total of about $750,000 to lend.

Although Prosper is among the first to try this business in the United States, the idea has a track record abroad. Zopa.com, which operates in Britain, introduced a similar service in March (also with backing from Benchmark Capital) and has attracted more than 50,000 registered users, said Richard Duvall, Zopa's chief executive. At any given time, he said, about 15 percent of the users are either lending or borrowing money.

Mr. Duvall would not disclose the privately held company's revenues, but said he was "very pleased with our numbers" — so much so that he planned to start a site in the United States to compete with Prosper this year. Mr. Duvall said Zopa would also soon let users affiliate in groups, as Prosper does.

According to Asaf Buchner, a financial services analyst with the Internet consultancy Jupiter Research, that component could be critical to these sites becoming profitable.

Mr. Buchner notes that Prosper's group leaders receive a commission on the group's lending and borrowing activities, which they sometimes share among the group.

"If the sites are able to recruit strong group leaders with strong affiliations, they shift the marketing burden to those people, who have the incentive to go after others to become part of the group," Mr. Buchner said.

The group approach enticed at least one of Prosper's lenders, Stephen Russell, who registered with the site during its testing phase, and who is the brother of a Prosper engineer. Mr. Russell, the chief executive of a San Francisco technology company, 3VR Security, has put up $25,000 to invest on the site. He has also started a group to lend money to people affiliated with the Climb High Foundation, which trains women in tourist destinations to become climbing and trekking guides.

"I'm not just optimizing the rate of return on my assets," Mr. Russell said. "It's also a way to facilitate lending that'll help women in developing countries. That takes the lending and borrowing process one step further."

as mentioned in the article, Zopa.com had this awhile back, I haven't kept up with the news, but there is some discussion in the archives about Zopa. An interesting question that you have, "How many more points will someone have to pay me to take on the added risk of lending to someone I don't know and taking payments over a 3 year term? Would a 2% premium be enough? 5%?"

I guess the answer for me probably is somewhere in the range of less than what credit cards offer? (anywhere between 9% and 15%?) Otherwise, people would just borrow money from their credit cards.

what's interesting is people with AA or A credit that want to take out small loans at 7% to 12% when they could easily get a 0%BT with a major credit card company. Sure a 0% BT might only be 1 year when they are looking for 3 yrs or more, but they could always roll that over into another 0% BT when the current one expires

I love the idea. The more competition the banks have, the better. Fraud and defaults will be problems, for sure, but I might be game for diversifying and making a bunch of small loans. I'm definitely going to look more closely at this. Anyone try it yet?

isobro said:I registered, and I will be throwing $100 at it...

Let us know if you receive any late $3.xx monthly payments!

I agree that novelty is probably the primary motivator, but IF the site gains enough traction to have a really large number of loans, it might be interesting as real investment, since you could allocate your loaned money across a large number of borrowers, gaining some protection against defaults, like soupcxan mentioned (multiple micro loans).

I noticed that they ask lenders for their SSN. Can anyone confirm if they pull your credit (for lenders)?

I've been excited to see something like this in the US ever since I learned about Zopa, so I signed up and decided to create a group.

I have two main concerns, though:

1. Legal ramifications of being a group leader (don't want to get sued for adding people to a group who might not be reputable)
   
2. Proper risk management of lent money (do I really trust Prosper to do this correctly?)

People,

These "risk spreading" schemes have been around for quite some time and are ALL extremely risky (not to mention that quite a few of them are illegal). It is absolutely true that sophisticated institutional lenders rely on spreading credit risk but that is not the only key to their success. In order to make money in the lending industry, you must correctly measure credit risk and price it accordingly, structuring loans as appropriate. Further, you need to have the expertise to conduct due diligence, to alter loan terms, as necessary, to make sure that the legal structure of the loans is sound, to properly, aggressively and cost effectively enforce the terms of the loans, etc...

In these schemes, you are blindly relying on the expertise of the operators of the website to do all of the above without any assurance that it is being done correctly (or being done at all), competently and cost effectively. As such, engaging in these schemes amounts to extremely risky gambling.

xpguy said:mhesidence said:
I don't know about you but I get bombarded with 4.99%, 3.99%, 2.99%, .99%, 0% convience checks all the time. I'm sure anyone with good credit also sees theses things. Even if you don't get any mail, on Chase or Citi advertisments, you see 0% BT all the time. So why even bother to borrow at 7% through Zopa or Prosper when these people can get 4.99%?

On top of that, Prosper charges borrowers a 1% loan arrangement fee. You're right that Prosper loans probably don't make sense for high-grade borrowers in most situations. It also doesn't make sense for Prosper lenders to lend to high-grade borrowers at competitive rates since lenders can get similar returns for less/no risk (CD's, etc.). As I see it, the core market for Prosper is the mid or low-grade borrower who either doesn't know about better loans or can't get them. This ought to be an interesting experiment for those who have money they can risk and want to lend.

BusinessWeek has put out an article on Prosper today as well:

http://www.businessweek.com/technology/content/feb2006/tc20060213_147523.htm

Here's an interesting blurb. Zopa lenders are averaging 7% returns and no one has yet defaulted:

"Plus, there's some track record now. Zopa, which started last March with a similar service in the UK, plans to enter the U.S. market sometime this year, says CEO Richard Duvall. He says that so far, the service has had no defaults thanks to rigorous screening of borrowers, while providing lenders an average 7% return. 'The eBay phenomenon made people realize they could do business with people they don't know,' he says."

Another article points out that Zopa doesn't charge lenders any fees. Interesting.