Wednesday, July 11, 2012

Become your own Bank

Advertisements surround us showing great 1.05% interest rates on Certificate of Deposits (CDs) and savings accounts.  Meanwhile, the same bank is loaning your money for a personal loan at rates over 12% interest.  Doesn’t seem fair right?  Especially when you consider inflation, then you are just losing money by saving. 

So what can be done to curb this trend?  How about becoming your own bank?  The idea sounds expensive, but about a year ago I saw a report on a company called Prosper Marketplace who provided peer to peer lending.  The idea sounds simple enough, take out the bank and the barrower gets a smaller rate and the lender gets a larger rate.  On paper, everyone wins.  I was quickly excited to try this idea back then and I was hit with the problem of being stationed in a state who did not allow for peer to peer lending.  Just over a month ago, I saw another article on this company and decided to give it another shot to see if regulations have changed.  Unfortunately the citizens of this state cannot use the product, but instead Prosper has added a way to check a box if you are military and provide what state you are from.  Great! They have created a work around for those displaced due to military service.  So my account became funded.

Looking around the program, the interface is rather simple to use.  In a way it feels like Facebook as I browse the profiles of people requesting money for loans.  The reasons people need money are endless.  But like I said, this is like Facebook, and talk is cheap.  Prosper does require the lenders to provide a copy of their social security card, photo identification, proof of income, and other documents to prove the person is who they claim to be.  Additionally, the lender is able to see a current credit report on the borrower to see information such as delinquencies, credit card usage, inquiries, and credit score.

I would like to toss out a word of caution.  The website may attract investors to choose higher risk investments because of the high yields and deter investors from the safer investments due to the lower yields.  But the reality is that people can and will default on these loans.  Just like the stock market goes down, so can this investment.  It is not a sure thing. 

So what can you do to mitigate the risk?  There are plenty of blogs out there providing advice on how to play the game.  Some people talk about the character and sincerity of the person requesting the money.  At the same time they discuss not investing in people who do not provide information.  That may be your thing, who knows.  But again, my opinion is that talk is cheap.  I can ask for a loan to pay for my son’s college tuition, but then use it to go on a cruise.  I have discovered in my month as a Prosper lender an amazing site,  This site allows you to query all of Prosper’s data since they converted to their current system.  Since this 3 years worth of data, and 3 years is the most common loan length, you can get a historical data on what is safe and not.   I by no means am giving advice on how to invest your money, but some things to look at are new borrowers to previous borrowers, numbers of inquiries, number of delinquencies, and so on to see how loans have performed.  Additionally, you can look at other users’ accounts and see how they have invested to learn from their successes and mistakes.  Or even see where you are going right and wrong in your own account.

An additional mitigation tool is diversification.  Prosper’s blog provides data reflecting since the change in their program three years ago, all lenders with over 100 notes have some form of positive growth.  Wow, 100 notes, which must cost a lot.  But actually it doesn’t.  The minimum amount you can pledge to the loan is $25, making it cost only $2500 to own 100 notes. 
To me, the process is painful at first, as I am big into the stock market.  I like to see my money change every second.  But initially, Prosper moves at a slower pace.  When a listing is posted it has fourteen days to collect funds from the lenders.  Once the loan is funded, it can take another seven days to have the borrow provide the required documents, and be verified by Prosper’s personnel.  So three weeks could potentially by before you can begin to collect interest on your investment.  But when you have a three year loan and average out the wait time, it becomes 51 weeks a year of interest.  Not so bad after the wait.  In fact the stock market is closed for holidays making the wait comparable. 

And additional wait is the fact you are investing into a loan.  The person receiving the money isn’t going to pay you back right away.  There becomes a 30 day wait before the first payment is due to you.  This is why I have decided to write this blog today.  My 30 day wait will come due on Friday and I will begin to collect my little bundles of money.  If you have over 100 notes, then everyday will be a pay day.
After this first month, I have learned a lot.  One thing to remember, this is like investing in the stock market.  Your intent is to make money.  Earlier, I mention people talked about the importance of what they place in the loan’s listing.  Personally I believe in historical numbers.  If you play the stock market on emotion, you will get burned.  If you invest on emotion, and not numbers, you will probably try to buy stock in Enron after Ken Lay said it was a good idea. 

I will continue to update on my success as a bank.  Please feel free to give it a try.  It is completely free to lenders and it is free for borrowers to list a loan. 

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