My Personal Finance Blog

As I write this post, my latest $100 transfer slowly makes it’s way from my bank to my Prosper account. On May 11th at 5 PM, the deposit will become available for me to bid, bringing my total investment to date to $1000.

Either I’m good at picking loans or just lucky but I’ve funded 18 of them, received payments on 10, and have not had any late payments to date. In this post, I’ll provide the details of my performance as well as provide some tips for maximizing your returns from Prosper. Bear in mind that I am not an expert at this, I’m merely providing you with my opinion and what’s been working for me. There is a good chance that one or more of my loans will default at some point. Please do your own due diligence on any loans you make.

So how am I doing…

So far so good. I cranked up my risk slightly in the past month, raising my average interest rate from 13.96% to just over 15%. By reinvesting the payments I’ve received the total balance of my loans is still right around the money I’ve put in with an additional $12 in payments in transit. These funds too will be reinvested along with additional deposits allowing me to receive compound gains from this investment. The current value of my account is $911.11 representing a 1.23% gain since I funded my first loan at the beginning of March. This rate should continue to increase as interest accrues on the newer loans I’ve made.

Here is a screen grab of my quarterly summary:

Note that the APY (Annual Percentage Yield) is lower than the average interest rate. This is due in part to some of the loans being new and in the case of some of my Q1 2006 loans, prepayments. On one loan I’ve received 2 extra payments and on another I’ve received 1. This actually lowers the rate of return for the loan. Not a problem though since I’m reinvesting the payments fairly quickly anyway. I’d also rather get paid back early than not at all…

I will likely be investing more in Prosper over the course of the next month or so as I plan investing a small portion of a recent 0% balance transfer as well as some of the proceeds from a horse we will likely sell in the next few weeks.

How I decide which loans to fund

I wish I could say it was a complete scientific process but it’s not… There are however a few things you can do to maximize your return and hopefully minimize your risk.

First off, I use a handy tool at SavageNumber which shows a great chart of all open loans sorted by credit grade and interest rate. This allows you to fairly quickly spot loans that are paying a higher than average interest rate for the credit grade they are in. Do not just automatically bid on the highest interest loans however! The tool is a starting point, not the end of your research. I’ve been focussing mainly on C and D credit borrowers lately because they represent a sweet spot in the risk adjusted interest rate curve. By risk adjusted, I am referring to the interest rate of the loan, adjusted for it’s statistical likelyhood to default. SavageNumber comes through again with both a chart showing both adjusted and non-adjusted rates. Note that this data is really only useful for borrowers with a Debt to Income ration (DTI) of less than 20%. I have made a couple of loans to high DTI borrowers but unless there are special circumstances I wouldn’t recommend you make it a common practise.

The next step is to look over the listings that have caught your eye from using the tool mentioned above. Did the borrower provide good detail regarding why they need the loan? Specifically I look for evidence that they have really turned the corner in their life and are on the road to good credit. I typically avoid loans where the borrower sounds desperate and have continuous problems (with the exception of a few ‘charity loans’ which I’ll explain below.) I truly feel for people who are in financial trouble, I was there myself at one point. What I’ve found though is that some people are just programmed to constantly be in adverse situations either through repeated, dumb mistakes or some attitudinal issues which they refuse to acknowledge and correct. Obviously this is a very subjective thing, the test on the loan listing is entered by the borrower and they could be a good liar or you may miss out on a good loan that just wasn’t written well. Again this is just a piece of the puzzle.

Next look at the credit history section that Prosper recently added to each loan display, it looks like this:

I’m not turned off by delinquencies in the past 7 years or public records. The Now Delinquent value is something I look at as well as the number of inquiries in the last six months. Both values can indicate that the borrower is in a desperate situation that you don’t want to participate in. I don’t not want to be involved in a decision between feeding their kids or making their loan payment. Guess who would lose… Again, we’re looking for people who are on their way out of trouble, not in.

Now look at how much the borrower is looking for. Does the amount match the story they’ve laid out? Are they consolidating debt or is this new debt? A rule of thumb I follow is that AA, A and B credit borrowers can ask for up to the $25K max. C and D borrowers I like to be less than that. I want the borrower to be able to afford to pay back the money they are borrowing. If the borrower has tried several listings (and many have) you may be able to estimate their yearly income using this calculator. Enter in the details from two of their listings with the greatest spread in DTI and or loan amount and it will give you an approximate income range. Does their income fit the loan or are they getting in over their head?

There are really two ways you can approach the next step. One way, is to contact the borrower and ask for documentation regarding the story they’ve told in their loan listing (the did provide detail right? If not, move on…) This is somewhat time consuming and doesn’t fit in with my overall strategy. Since I’ve never done it, I won’t go into detail here.

The process I personally follow next is to look at how many people have funded the loan. If the loan is fully funded or close to it I’ll consider it positively. Again, my strategy has been to make many many small ($50) loans so spending the time to vet borrowers doesn’t make sense in my case. I will eventually have hundreds of loans so my results should approach the statistical averages for defaults as listed below.

Experian Default Rates
AA: .2% Default
A: .9% Default
B: 1.8%% Default
C: 3.3%% Default
D: 6.2% Default
E: 11.1% Default
HR: 19.1% Default
NC: Cannot Estimate

Which brings me to my last tip. Before placing my bid I go to SavageNumber one last time and plug the loan’s details into his Expected Return calculator. Try plugging in any HR loan’s details and you’ll fairly quickly see why I don’t like bidding on them unless I either have a very good feeling for the borrower or it’s a ‘charity loan’.

Good luck and good bidding. If you’re a Personal Finance Blogger or one of our readers consider joining the Personal Finance Bloggers group on Prosper. The focus of the group is on helping people who are financially aware get out of debt or at least consolidate payments. If this is you I’d love to help you out. There are few requirements to join the group but I will personally vet any loan requests made by group members so that other members might bid on them more confidently. I would also give strong consideration to funding members of the group as we have some connection outside of Prosper alone.

What the heck is a charity loan?

Once in a while you come across a loan where the story grabs you even if the fundamentals of the loan do not. There are sincere people out there who have had some tough breaks. They may want to pay you back what they borrow and just not be capable of it. I’ve bid on a couple and had one fund. I hope to get my money back but if not I’ll chalk it up to my having helped someone who needed it. This is after all part of the draw of Prosper for me in any case.