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Why is This E-Grade Loan Paying Just 6% Interest?

by Peter Renton on January 24, 2012

I first noticed this in one of my Lending Club accounts about a year ago. It was a C-grade loan that went from 14% and was suddenly paying 6%. I thought it must have been a mistake but when I did some investigating I discovered this 6% rate was indeed correct. How can that be?

I didn’t think much more about it because it was an isolated incident that hasn’t happened since. Then yesterday, I noticed this tweet from Michael at Nickel Steamroller. There are several low grade loans for sale right now on Folio with a 6% interest rate including this E-grade loan. What gives?

Active Duty Military Can Only be Charged 6% While Deployed

These loans didn’t start out at 6%. They were normal loans with an interest rate commensurate with the credit risk. But there is a law called the Servicemembers Civil Relief Act (SCRA) that states that when active duty military are deployed they can only be charged a maximum of 6% on any debt incurred prior to their deployment. Here is the pertinent information. This act:

Clarifies and restates existing law that limits to 6 percent interest on credit obligations incurred prior to military service or activation, including credit card debt, for active duty servicemembers. The SCRA unambiguously states that no interest above 6 percent can accrue for credit obligations (that were established prior to active duty or activation) while on active duty, nor can that excess interest become due once the servicemember leaves active duty – instead that portion above 6 percent is permanently forgiven. Furthermore, the monthly payment must be reduced by the amount of interest saved during the covered period.

This is not an issue that impacts many investors. Of the more than 30,000 loans that are active right now at Lending Club only 11 of them have been adjusted down to this 6% rate. I don’t have the numbers for Prosper but I imagine it is a similar tiny percentage.

So sure, as an investor you may lose a little in interest but that doesn’t worry me in the least. In fact, I look at it as just a way to provide support for those hardworking men and women serving our country. In my case the 6% C-grade loan stayed that way for several months and then it returned back to its normal interest rate and the borrower continued making payments.

{ 57 comments… read them below or add one }

Dan B February 5, 2012 at 5:36 am

Roy S………….With all the talk of soldiers & submarines, which was mostly my fault, I hope that you’ve nevertheless received some sort of response from Prosper to your very legitimate inquiry ? Please update us.

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Roy S February 5, 2012 at 10:54 am

I have not heard anything as of yet. I believe Glenn said he would run it up the flagpole and see what senior management thinks. Until I hear anything, I just have to go by what Lendstats has…9.16% as of today. (It has been hovering around 9.1 – 9.3% over the past week or 2.) The ROI jumps to 10.42% removing the loss factors for all but the loans that have defaulted.

So there’s still a wide range. My assumption is that it will ultimately end up around 8.5 – 9%, which is still a good return (and better than LC), but short of what Prosper is predicting.

My personal mindset has always been to under-promise and over-deliver. In my opinion, the only reason for Prosper to have posted that 10.69% would if they were expecting returns to come in at 11 or 11.5% percent. Likewise, if they were predicting 10.69%, personally, I would have put out a number closer to (or below) 10%. 10% is still above LC, but it gives them a little wiggle room (especially when they don’t have a lot of historical data). If you predict 10% and the ROI is only 9.5%, people will be a lot less jaded than if you predicted 10.69%. But that’s just my humble opinion…

Maybe this is me being a little jaded, but my other view is that they are currently projecting less than 10.69% for this specific subset of Notes. Why change the subset of Notes and have the ROI go down unless the ROI went down a lot further if they kept with the same subset? Obviously, they are trying to keep with the 10-month “seasoned loans,” but it’s still a question in the back of my mind.

Overall, it is really difficult for me to trust anything that comes from Prosper. The problem is that, a year later, my investment is still doing well. So I’m just a little conflicted over Prosper. In the end, though, regardless of what Prosper puts out there the only thing that really matters is whether I’m making money. As long as I’m making money, and the ROI is higher than I can get elsewhere for the same or less risk then I’ll stick with them. So far that has been the case…

Reply

Peter Renton February 6, 2012 at 5:29 pm

@Roy, I think having accountability like this would be a great thing for the industry. Not just for Prosper but Lending Club as well. Lending Club don’t claim one number any more but they claim a number for each credit grade which is in essence the same thing. I am talking about this page here:
https://www.lendingclub.com/public/steady-returns.action

What would be great would be to see the difference between the return that was promoted and the final return. According to Lendstats the returns for Lending Club loans issued in 2008 (which have all reach maturity now) was around 2%. Not a great return at all and nowhere near the 9% number bandied around back then. We know Prosper’s numbers from that year are much worse.

It will be interesting to see by the end of this year how the small batch of loans issued by Prosper in 2009 fared. So far, it is looking pretty good but it will most likely be well below 10%.

I am chatting with Joe Toms, Prosper’s chief investment officer later this week and I will certainly raise this issue with him. A look back at actual returns versus predicted returns would be very useful for investors.

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Dan B February 6, 2012 at 6:17 pm

Peter said……….It will be interesting to see by the end of this year how the small batch of loans issued by Prosper in 2009 fared. So far, it is looking pretty good but it will most likely be well below 10%.

Really? I think that’s a pretty safe bet considering that it can’t actually be any higher than 8.5% unless some of the late loans come back to life. Fat chance of that occurring. Furthermore, if ever single one of the close to 900 notes still out there remains current & completes the 3 years then it’ll come in at 8.5%. That, of course won’t happen either. My best estimate is that another 40-50 of the current notes will go bad before it’s all said & done. So it should end up at 8%. A good number no doubt, but keep in mind this is a number achieved when investors set the interest rates, as opposed to how it is today with Prosper 2.5 (post Dec 2010) where Prosper sets the rate.

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Peter Renton February 6, 2012 at 11:47 pm

@Dan, I think 8% is pretty good, particularly when you compare it to previous years. I expect investors who took the plunge in 2009 will be happy with their returns.

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Dan B February 9, 2012 at 3:15 pm

Peter……….Make sure you ask Prosper’s chief investment officer why they’re heavily pushing the benefits of 5 year loans to investors today when not 3 months ago it was written right on this blog that Prosper stayed away from 5 year loans as they were seen as high risk.

I can see the answer coming now. Some BS about constantly reassessing risks & combined with spin, propaganda & more BS. All that would be completely expected. The only thing that remains to be seen is whether you, Peter, allows them to get away with it or not.

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Peter Renton February 9, 2012 at 4:01 pm

@Dan, Wow, you are starting to sound like some of the guys on Prospers.org – that absolutely everything that Prosper does is bad and all their marketing is BS and everyone who works there is inept. I am not buying it.

I try and look objectively at both Lending Club and Prosper – but as we have discussed before I do look at things in a more positive way than most. The bottom line for me is are they producing excellent returns for investors. If the answer is yes, which it has been for me, then I will continue to be a cheerleader for the industry.

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