I will admit that I don’t have the best credit score in the world. When I have needed financing in the past, it has been tough. At one point, I thought to check out Peer-to-peer lenders such as Prosper and Lending Club. I gave up on that idea pretty quick. I’ve come to the conclusion that P2P lending is pretty much a scam.
Okay, scam may be a pretty strong word, but I’ll explain my reasoning behind that later. But at the very least, it’s a huge rip-off.
P2P Lending for Borrowers
When I was researching this post, Prosper is willing to lend money to someone of my credit score (680) at a mere 20.88% APR. Lending Club wouldn’t even think of extending credit to me*. But on their compare rates page, they admit to having rates at high as 27.99% That was the default rate on my last credit card!
*Lending Club advertises that their average borrow has a credit score of 715, debt-to-income ratio of 14.98%, 15.21 year credit history, and income of $68,000. My score is 32 points lower, by debt to income ratio is 9%, 13 year credit history, and our household income is almost $55,000. I beat or at least come close to all of the criteria. But I do have defaults 4 years ago that are now all listed as “paid” or “pays as agreed.”
So, these places position themselves as an alternative to bank loans, but make themselves unavailable, or available at ridiculous rates, to the people that need those alternatives the most.
That 20.88% APR for Prosper? I was getting off light. On their listing of featured loans, 13 out of the 25 showed a rate of over 30%
Even for better qualified borrowers, their rates don’t seem that good to me. Lending Club’s borrower stories page features three people. The lowest had a rate of 9.98%. That’s higher than the rate I got on my medical loan, which didn’t even require a credit check. The other two stories show rates of around 16%. That just happens to be the rate my wife got on the debt consolidation loan she once got from a retail bank with “good” credit. (ahh, those days! Hopefully one day again.)
But isn’t that their entire value proposition offering better rates to borrowers and better returns to lenders, but “cutting out the middle man?” Lenders may be getting better rates then they could elsewhere, but P2P loan companies are certainly not cutting out any middle men.
P2P Lending for Lenders
Retire By 40 has written a lot about his experiences investing in P2P lending. It seems to be overall positive, but somewhat hit or miss. The rates do look nice; as of this past July, he was getting an annualized return of just over 11% on $10,000. Lending Club also likes to brag that nobody with at least 800 notes has ever lost money.
Of course, 800 notes works out to an investment of at least 20,000. If I ever have nearly a year’s worth of income, I’ll keep that in mind. But notes can be as low as $25, so investing for the small fry is possible. And I’m sure that’s how they suck you in.
Personally, I don’t care how good the returns may be with P2P lending. I don’t agree with their lending practices so I won’t invest my money with them. I don’t do a lot of socially responsible lending (although I do have one mutual fund labeled as such in my IRA), but I do draw firm lines in the sand when it comes to my money and companies with whom I don’t agree.
For instance, I haven’t been to Ruby Tuesday’s ever since a friend of mine got fired as a server there. He got a bad review from a secret shopper when they pulled him away from eating his only allowed meal during a religious fast. You are going to do that to a guy and expect great service?
That’s how I reacted to the treatment of one person whose situation I understood well. I can’t imagine I’d want to treat a company any better than takes advantage of millions of people in situations similar to mine.
P2P Lending for the companies
However nice the rates may look, the cut they are taking is fantastic. Considering these companies are simply acting as a marketplace and don’t take on any of the lending risk themselves. Lending Club advertises that Grade A borrowers have an average rate of 7.51%. Lenders lending to Grade A borrowers get an average of 5.71%. That’s a spread of 1.8 percentage points.
So far, that’s not too bad and better than most banks. But as the risks go up, the larger cut they take. For the highest risk, Grade G, borrowers pay an average of 22.31% in interest, but lenders only receive an average of 12.21% That’s a spread of over 10 percentage points!
By being a higher risk of default, borrowers pay three times as much but lenders only get twice as much. Lending Club’s cut increases by more than five and a half times. But they only risk loosing revenue, not any actual investment. And at a cut nearly 6 times higher, they can see more than five times the default rate before their revenue is smaller, per dollar passing through their servers, than those of the lowest risk.
When banks lend, they take on actual risk. Assuming they didn’t “securitize” the loan and offload that risk to a million other people, then if a borrower defaults, they have limited ways of getting their money back. Interest rates are a function of that risk. If everyone had the same risk of default, everyone would pay the same interest rate.
Since borrowers do have different risk profiles, they should pay different rates. Since lenders are accepting different risk profiles, they should receive different rates.
But P2P companies have exactly the same risk of loosing money: none. So I see no reason why their cut of each transaction should vary. Do eBay sellers with lower rating pay higher PayPal fees?
Have you ever borrowed or invested through P2P lending? What was your experience?