1/23/08

Get Higher Yields By Purchasing Loans

Update: 8/30/08

Original post follows:


With the fresh .75% interest rate cut by the Fed and new cuts presumably to follow, yields on savings and money market accounts, and certificates of deposit will go from low to pretty much nothing. Treasury notes and bonds aren't paying much either, though bonds may make up for it by rising in value.

If you're thinking about putting more money in dividend paying stocks or corporate bonds to make up the difference, you may want to consider diversifying a bit by purchasing loans from regular people like yourself. A few so called peer-to-peer lending sites have sprung up recently. These include LendingClub, Zopa.com, and Prosper.com. There is also something similar called Loanio, which is not yet live. Currently, LendingClub "lenders" are earning an average of 12.15%, Zopa "investors" are earning "up to 5.1%," and Prosper lenders are earning from around 9.49 to 12.81%.

So far, I only have experience with Prosper. There, I've "lent" small sums to two people (more to follow), and am currently yielding an average 9.5%.

Prosper works in the following way. Potential borrowers need money, for business expansion, debt consolidation, etc (some of it is not so smart, actually, e.g., I saw a couple of people trying to borrow money to go on vacation). Prosper does thorough credit checks, gives borrowers a credit rating, and then lets potential "lenders" bid on their loans. "Lenders" can bid a minimum of $50 to a maximum of $25,000. When bidding, "lenders" specify the lowest interest rate they are willing to accept from the borrower. The lowest bids are accepted, and when, within a specified time (sort of like in an Ebay auction), the borrower's full amount is funded, the loan begins. The borrower makes monthly payments, which the "lenders" collect. Prosper charges the borrower a fee and also takes a small percentage of the repayments.

I've been putting "lenders" in scare quotes. This is because they're not really lending anything; they are purchasing loans. They are investors, but Prosper, the loan originator, calls them "lenders." (This is a great business model, and if Prosper were a publicly traded company, I'm pretty sure I would invest in it.)

At Prosper you have a choice between putting your money in portfolio plans, which are categorized by the credit ratings of borrowers and are supposed to spread your risk among many borrowers, and looking for borrowers yourself. For the latter option, there are a lot of criteria you can use in conducting your search, including borrower income, credit rating, past loans, etc. I try to limit my investments in people borrowing smaller sums (under $10,000) and for what I feel are legitimate reasons (financially). That is, I avoid the vacation people, because that's just irresponsible.

(A self promotional aside, but you get something out of it too: If you decide to sign up, note that Prosper offers $25 to new "lenders" who are referred. The referrers get $25 too. You get your money after you "lend" $50. Not a bad deal--a 25% return right away. If you're interested and need a referral, click here or on the ad at the upper right of this page.)

LendingClub, from what I understand, works very similarly to Prosper. As such, I do not have much to say about it. I encourage you to check it out. As far as I know, Lending Club also has a referral bonus. I am not a member (yet), so at this time I can't provide a referral link. Searching for lendinglcub referral, however, may help you get the bonus.

If you use the above sites, please remember that you're buying unsecured debt. The borrowers may default. While collection agencies can probably get you some of your money back, it pays to be cautious. Spread the risk among as many borrowers as you can.

You may have noticed that Zopa has a lower yield than Prosper and LendingClub. This is because Zopa works differently. It sells debt ("Zopa CDs") guaranteed by credit unions and insured by the National Credit Union Administration. In borrowing and lending, Zopa users become members of the participating credit unions. This is much less risky than Prosper and LendingClub, but your potential return is lower. Nonetheless, it is better than what you can get at a regular bank.

Although I've only talked about it from a lender's perspective, borrowers may be interested in these sites too. If you're a borrower, be sure to include the above sites in your comparison shopping. You might find a lower rate.

Finally, please note that these sites are relatively new. My own experience is limited, but so far I'm happy. You might want to look up user reviews before jumping in.

Happy investing.