Prosper Marketplace Peer to Peer Loans
Prosper Marketplace (San Francisco, CA) offers personal loans, including student loans, with interest rates set through a bidding system. (The student loans are the same as the other person-to-person loans with no terms specifically geared to students.) Prospective borrowers post a listing seeking a 3-year unsecured loan of $1,000 to $25,000 at a specified maximum interest rate (no more than 36%). Lenders place bids of $50 up to the amount of the loan at interest rates at or below the listing rates. Prosper combines the bids with the lowest interest rates into one loan to the borrower. The competition among lenders has the potential to drive down the interest rates. Borrowers can increase the likelihood of fully-funding their loan by starting off with a higher interest rate (typically slightly less than the rate on alternate sources of financing available to the borrower). Prosper handles the loan servicing and receives a one-time borrower fee of 1% to 3% deducted from the funded loan amount and an annual 1% servicing fee from the lender. There is no prepayment penalty.
Borrower fees include a 1% to 3% closing fee, depending on the credit grade (1% AA, 2% A-B, 3% C-HR), that is deducted from the disbursement check. There is a 1% discount for use of electronic funds transfer for the monthly payments (excluding bank drafts). There is a $15 failed payment fee (paid to Prosper). There is a late payment fee of $15 or 5% of the unpaid installment, whichever is greater (paid to the lender), if the payment is more than 15 days late. Lender fees include a 1% annual loan servicing fee (based on the current outstanding loan principal). (Since the servicing fee is based on the outstanding principal, it effectively represents less than a 50 basis point hit to the spread.) If the loan is delinquent, collection agencies chosen by Prosper may charge up to 30% of the amount recovered. There is a 100% identity theft guarantee.
The credit grades classify the prospective borrowers according to risk of default and correspond roughly to credit scores: AA (760+), A (720-759), B (680-719), C (640-679), D (600-639), E (560-599), HR (520-599). HR stands for High Risk. Borrowers must have a credit score of at least 520. The D, E and HR credit grades are considered subprime. Prosper will refresh the listed credit grade upon posting of a new loan listing for the borrower, provided that at least 30 days have passed since the most recent credit pull. Credit scores are based on the Experian Scorex PLUS model. Approximately 40% of funded loans are obtained by borrowers with credit grades of AA and A, approximately 55% by borrowers with credit grades of B, C and D, and approximately 5% by borrowers with credit grades of E and HR. So although Prosper allows borrowers with credit scores below 600, the likelihood of obtaining a loan with a subprime credit score is very low.
The overall historical average interest rates vary from 7.9% (AA) to 31.88% (E). However, the average annual returns will be reduced by the net defaults and various fees. As of July 4, 2008, there were 115 loans totalling $640,551 in the "student use" category, an average of $5,570 per loan. The rates in the listings varied from 8.13% to 35%, with a weighted average of 26.1%. Even among the AA rated loans the weighted average interest rate was 13.4%. (Note that these are the listing rates. The actual interest rates on funded loans may be lower. Nevertheless, these rates appear to be higher than rates available on private and federal student loans.)
Lenders can pick individual borrowers or use a "portfolio plan" that bids on a collection of borrowers according to the lender's risk preferences (very low, low, medium and higher risk). Lenders and borrowers can also create a "group" (a kind of affiliated community) for lending within the group's membership.
Defaults significantly impact the average annual return. While borrowers with inferior credit grades may offer a higher average lender rate, the net annual return after subtracting the net defaults is highest with the AA credit grade.
Prosper provides a useful tool for reviewing overall default and delinquency rates as well as the default and delinquency rates disaggregated by credit grade. For example, for loans originated from November 2005 to July 2008 9.5% of borrowers were 30 or more days delinquent and 6.2% had defaulted as of July 2008. (Prosper defines a default as being 4 months delinquent.) The delinquency rates were lower than average for grades AA, A and B. However, since these loans are three-year obligations, recently originated loans do not yet have a complete repayment history. If one looks at loans originated in 2006 as of July 2008, the overall borrower delinquency rate is 11.9% and the borrower default rate is 18.6%. (As of July 2007 the borrower delinquency rate was 9.9% and the borrower default rate was 6.1%.) The overall borrower delinquency rate for loans originated in 2007 is 13.7% with a borrower default rate of 4.0% as of July 2008.
Beware of Prosper's estimated return chart in the higher risk tutorial as this chart excludes borrowers with current delinquencies, yielding an estimated annual return that may be higher than the performance of the typical Prosper lender. While this chart shows a positive annual return for all credit grades, and the highest for the E-rated loans, for loans originated in 2006 the E and HR credit grades are negative and the annual return is highest for the AA credit grade. For loans originated in 2007 only the A and AA loans have a positive average annual return, mostly due to higher default rates than in 2006.
Delinquencies and defaults are reported to the credit reporting agencies, as are payments, so the borrower's repayment behavior can positively or negatively affect their credit score. Social pressure is also used to encourage prompt payment, with notifications sent to the Prosper 'friends' and group leaders of borrowers who do not pay on time.
Prosper launched on February 5, 2006. Loan purpose categories were added in December 2007.
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