We recently kicked off #YakChat on Twitter a couple weeks ago and it was so much fun! Given most of us work and/or have families, we’ve chosen 6pm PST / 9pm EST every second and fourth Wednesday of the month to engage. With a spacing of every two weeks, the idea is to give the Yakezie Community a chance to connect, discuss something educational, and promote and welcome an expert in the field of discussion.
At the end of each hour long #YakChat, we’ll highlight some of the things we’ve learned in a post like I’m writing today. Knowledge is power, and I’m convinced that the more we know, the wealthier and happier we’ll be. Each #YakChat will have Yakezie Member act as the main moderator who will be responsible for gathering pertinent questions, connecting with an expert, and if possible finding a sponsor as a bonus. The host of a particular #YakChat session will then type up his or her notes in a post and publish for all to read. Thanks to Daniel from Sweating The Big Stuff for kicking off the initiative and hosting the first round!
UNDERSTANDING SOCIAL LENDING IN A WORLD FULL OF INVESTMENT LANDMINES
Social lending or peer-to-peer lending as they call it is a new form of investing that is regulated by the SEC. From a lender’s perspective, the idea is that you too can become the bank and directly lend out your own money at rates generally higher than normal. According to Prosper.com, lenders average around 10.59% per annum, although results will vary. Compare 10.6% with the current 10-year yield of ~2%, you can see why social lending has become very attractive to many.
From the borrower’s perspective, they get to tap a new liquidity pool of capital which never existed before. Why wouldn’t the borrower just go to his or her local bank you ask? We learned on #YakChat that the reasons can be several fold:
1) The local bank lacks the flexibility in terms of loan duration. Let’s say you only want to borrow for 6 months. That’s a problem for banks because generally they will only lend out for longer durations.
2) There is massive amount of screening and paperwork by the banks that may go above and beyond what is necessary. This is not necessarily a bad thing, given if banks were more strict with their lending standards, perhaps the 2008 meltdown would not have occurred.
3) A borrower may have an unacceptable level credit score and can’t even get a loan. A borrower may have gone through a bankruptcy 4 years ago and has since cleaned up his balance sheet and found a higher paying job. But, because of the BK, banks won’t lend even at a higher borrowing rate. For a higher borrowing rate, P2P sites such as Prosper.com will match a willing lender to this borrower. According to Prosper.com though, the credit score of their “high-credit quality consumers” is roughly 731 based on Experian Scorex PLUS credit score.
EVERYTHING HAS A PRICE
The key fear for many on #YakChat is whether borrowers will default and lenders lose all their money. As a P2P lender, you can choose to lend to riskier borrowers at a higher interest rate, or to less-risky borrowers at a lower interest rate. It is up to you to construct a portfolio of enough borrowers so that if one defaults, your returns don’t overly suffer.
As I am personally a more conservative investor, I would choose the less-risky borrower, and spread my money across hundreds of lenders. If I can achieve a 6% return, or 3X that of the 10-year risk free rate, I’m happy. Part of the reason why I’m conservative is that I hate losing money and like to employ a large absolute amount of money in any investment I deem worthy. For those of you who plan to do P2P lending for fun and just throw in several thousand bucks, you might be more risk loving to seek higher returns.
Another concern from #YakChat is the amount of paperwork involved. Nobody likes paperwork, but Prosper.com mentioned that joining is just like opening up an account at your local bank or online broker. In other words, it’s no more or less painful than any other institution you join.
OTHER INTERESTING POINTS
The average balance at Prosper.com was hard to pin down. The range was wide i.e. $5,000 to a million bucks. The more important thing to understand is the median, which may tell us what the conviction level is of lenders in the program.
If you’ve only got $2,000 bucks investing in P2P lending, then you really don’t have much conviction because a 10% annual return is just $200. This is why it’s important when you read sites that strongly push P2P lending, and highlight their own fantastic returns to ask them straight up how much they have invested in P2P. If they don’t have at least $5,000, or better yet $10,000, then you have to question their conviction level. They may very well be making more affiliate revenue off of you than their returns!
It’s also good to understand how Prosper.com makes money. For borrowers there is a closing fee of 1% of the amount borrowed for AA-D credit grades, and 2% for E-HR credit grades. The minimum closing fee is set at $25. For non-electronic loan payments there is an additional 1% charge (this is an optional fee).
For lenders there is a 0.5% loan servicing fee for AA-A credit grades, and a 1% servicing fee for B-HR credit grades. These fees are deducted from each loan payment as they are received. So, for an E or HR loan Prosper is earning a total of 3% of the loan amount, while for an A or AA loan Prosper’s take is 1.5%. In other words, Prosper.com makes anywhere from 1.5-3% on every loan. Therefore, Prosper.com’s goal is to get as many lenders and borrowers as possible.
Prosper.com asked #YakChat a good question to wrap things up. Do you see social lending as an investment class? Anything that has to do with deploying capital to make returns is investing in my opinion. If you don’t know what you’re doing, you can lose money, which is why you need to educate yourself as much as possible! There is a reason why if you read Prosper.com’s prospectus that they recommend lenders make at least X amount of money and have Y amount of assets. You can most certainly lose money as there is no such thing as a risk free investment.
My largest hurdle, and perhaps for many others is that we are too lazy to learn and do. Learning about new asset classes takes time. Even after reading as much as we can, we still don’t know everything often times. As a result, I asked on #YakChat whether Prosper.com has a “concierge” type service where an individual representative sets everything up and invests your money based on your desired risk tolerance and target percentage returns. @Prosperloans said to check w/ Glenn, who is in charge of Prosper.com’s social media outreach. If concierge service is a possibility, I think Prosper.com can really differentiate itself and attract customers by highlighting this concierge/advisor role service. Perhaps put a cut off of $10,000 minimum investment and go from there.
Take a look at my two year performance review with Prosper I wrote in 2015.