7 Reasons Why You Should Consider Investing In Strangers Online

[Editor’s Note: The following article is a guest post written for Business Insider.]

It sounds ludicrous when you first hear it: Loan money to complete strangers online whom you have never met and know very little about. Then expect to be paid back, with interest, over typically three to five years.

But peer-to-peer lending, also known as p2p lending, is becoming very popular.

In fact, $2.4 billion in loans were made last year by the two leading p2p lending platforms, Lending Club and Prosper, and that number is expected to more than double this year.

Why the surge in popularity? Here are seven reasons why more and more people are discovering what a good idea it is to invest in our fellow Americans.

1. You are only lending money to prime borrowers.

One common misconception people have about p2p lending is that the borrowers on these sites must be people with poor credit who can’t get a loan elsewhere. This is simply not the case.

On Lending Club and Prosper, all approved borrowers have good credit, with an average FICO score of around 700 — the minimum FICO is 640 to even be considered for a loan.

Most of these borrowers have many options for a loan but have decided to take out a p2p loan because the interest rates are lower than they would have to pay on a credit card.

2. There is a strict and rigorous underwriting process.

Just because a borrower has a good credit score does not mean he or she will be automatically approved for a loan. Many investors are surprised by a rigorous underwriting process that leads to around 90% of borrower applications being rejected by the platforms. Full credit reports are pulled on every borrower, which ensures that only the most creditworthy of borrowers are made available to investors.

3. You get to decide which borrowers you want to invest in.

Every platform grades borrowers based on risk level, with interest rates set at rates commensurate with the perceived level of risk. When building a p2p lending investment portfolio, investors can pick and choose their borrowers one by one or let the platforms create a portfolio based on selected risk levels. Investors get to decide how much risk they are willing to take on.

4. You can invest as little as $25 in each loan.

This is one of the truly great things about p2p lending. Both Lending Club and Prosper allow a minimum investment of just $25 per loan. So, with a relatively small investment, it is easy to build a diversified portfolio of loans. Like any investment, it is important not to put your eggs in just one or two baskets. By building a portfolio of 200 loans or more, the negative impact of any individual borrower default is vastly reduced.

5. An annual default rate of 3-4%.

When most people first hear about p2p lending, they assume it must be very risky with high default rates. But the platforms have done an excellent job of mitigating the risk to investing in complete strangers. The average annual default rate is in the 3-4% range, and investors can even reduce that amount by investing in the most creditworthy of borrowers. For example, an A-grade loan at Lending Club, while providing a lower yield to investors, has an annual default rate of well under 1%.

6. The major platforms make their complete track records publicly available.

Peer-to-peer lending has been built in the spirit of transparency. Both Lending Club and Prosper make their entire multi-year loan history available for download. Investors can analyze this history in Excel or they can use a third-party statistics sites like NickelSteamroller.com, which provides an easy-to-use inquiry tool on loan history.

7. Consumer credit has been one of the highest returning assets classes for decades.

There’s a reason why banks continue to flood our mailboxes with credit card offers. Consumer credit has been one of the highest returning asset classes for decades, and until p2p lending came on the scene, this asset class was reserved only for banks.

Consider these numbers: In the first quarter of 2014, credit card interest rates averaged 13.14% while charge-offs were at 3.29%, leaving a net yield of close to 10%. Today, p2p lending provides the opportunity for everyday investors to, in effect, become banks and earn a high yield by investing in this established asset class.

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Dan B
Dan B
Jun. 2, 2014 2:29 pm

7 Reasons why you Shouldn’t Consider Investing in Strangers Online. A point by point rebuttal to the above article. And yes, this is being done for FREE!

1. Prime borrowers? Really? Since when has 660 been considered Prime?

2. Does that 90% number refer to people who actually complete the process & are then rejected, or does it also include people who don’t provide timely documentation & are rejected? Does the 90% include people who simply start the application process but are immediately rejected because they don’t meet the minimum 660? What percentage of people who complete the application & provide documentation are actually rejected? Because I know it’s not even close to 90% or 70% or…………

3.No, not really. Perhaps in the early days of 2007, but less & less with each passing year as anything that could be perceived as personal info. has been removed. The ability to ask personal questions removed. I could go on, but I’m sure everyone gets the point. Besides, in an extreme scenario none of this will matter because we’re investing in LC & Prosper lender dependent notes. Our returns are dependent not only on the individual borrowers, but also on the continued viability of LC as a business.

4. So what?

5.Yes, an annual default rate of 3-4% during the relatively “good” times. What was the default rate during the 2007-2008 period. Ask any early Prosper investor. They’ll laugh at you if you say 3-4%.
Also, 3-4% works out to 9-12% in the life of a 3 year loan & 15-20% in the life of a 5 year loan. Something to keep in mind so that your expectations are realistic.

6. See #3 Besides transparency is just a marketing term or talking point,…………. like peer to peer or debt consolidation or Priority Mail. It’s not meant to actually be taken that seriously. Also, as many LC secondary market users/traders would point out, transparency is pointless if the underlying data isn’t always accurate or timely.

7. No, not all consumer credit has been that profitable all that time. Specifically it has been credit card consumer credit that has been very profitable. We are not lending money via a credit card. On the contrary, if most lenders are indeed telling the truth, we are lending money so that they can pay down or pay off & close their credit cards. Credit cards have returned so well for investors because making a credit card payment frees up some credit. It keeps the addiction going for cash strapped credit card users. Making a p2p payment doesn’t have the same effect. The cash strapped borrower just sees the money disappear with no positive benefit in alleviating his situation.
Also…………..let us not forget that banks voluntarily abandoned this very same unsecured personal loan market that p2p investors are investing in. Why did they do so if it was so profitable? Because the unsecured personal loan category really wasn’t & the profits paled in comparison to……………..you guessed it, credit cards.
During recessions credit card default rates understandably spike. But banks normally still eke out a profit. Look at returns from the financial crisis period & see how these loans fared.

Dan B
Dan B
Jun. 4, 2014 4:43 pm
Reply to  Peter Renton

Peter, I don’t see any need to address your “responses” in detail. My above response wasn’t meant to be balanced, It was meant to be a one sided rebuttal to your highly optimistic one sided article. I’m confident that the readers here can reach their own conclusions based on what has already been discussed.

More importantly I’m confident that most people here know that you have an ever increasing vested interest in p2p & can determine for themselves to what extent those factors influences what you write & the acceptability of the spin you impart. They can determine for themselves whether your writings are to be taken seriously or merely dressed up fluff pieces meant at promoting an industry that, in a not so round about way, butters your bread.

I won’t be responding to any more comments on this thread so that the cheerleaders, apologists & p2p blog owners can now come to defend Peter.

New Jersey Guy
New Jersey Guy
Jun. 3, 2014 12:25 pm
Reply to  Dan B

DanB my old friend! Glad to see you’re alive and kickin’! Also happy to see that the “Glass is Half Empty” approach to life is also alive and well!

Keep up with those posts of encouragement! The forum just isn’t the same without your sage words of wisdom.

Catch up with you later! NJG

Ben H
Ben H
Jun. 8, 2014 6:39 am
Reply to  New Jersey Guy

I’m not a cheerleader because I guess I would prefer for this realm of investment to remain somewhat unknown. Pretty much everyone suffered losses in 2008 unless you were on the sidelines. P2P has provided me a great return over the years and the best part, like Peter said, is the low entry cost per note. The diversification and simple math helped me realize fairly early on that this is a great way to invest. DanB, can you show us an example of someone who has lost massively in P2P with proper allocation?

rawraw
rawraw
Jun. 2, 2014 4:57 pm

Not sure I’d define consumer credit as credit card loans. Not even the same structure as P2P loans.

rawraw
rawraw
Jun. 3, 2014 5:13 am
Reply to  Peter Renton

You are comparing apples-to-oranges. Although the defaults may be similar, what constitutes a default on a credit card vs a P2P loan? What is the min payment required on a revolving balance of the average sized P2P loan (I could guess $50 or something but I don’t carry balances, so don’t really know). These default rates are in no way measuring the same thing IMO.

Edward
Edward
Jun. 3, 2014 7:14 am
Reply to  Peter Renton

Peter,
The charge off rate you mentioned in your C4 example above takes in account all C4 loans does it not? If we assume that some loans are better than others, as a general concept, would you think that by using good filters or third-party services which offer their own ratings, that the charge off rates could be lower?

RawRaw
RawRaw
Jun. 3, 2014 12:19 pm
Reply to  Peter Renton

There are plenty of consumer data out there that you could use a proxy or Call Report data from banks you know that do unsecured consumer lending. Most of the data, however, isn’t free. But I’m sure there are academic papers which analyze consumer credit. I just get to see some of the non-free data in my day-to-day job.

Emmanuel
Jun. 3, 2014 9:00 am

About: 4. You can invest as little as $25 in each loan.

While I totally agree that’s the single most important part of investing in peer lending, I think Dan’s point is that the benefit is missing:

$25 in each loan = a few thousand dollars is enough to invest in hundreds of different loans = returns will be very stable (due to the Central Limit Theorem).

when he writes ‘So what?’.

New Jersey Guy
New Jersey Guy
Jun. 3, 2014 1:42 pm
Reply to  Peter Renton

Peter…now I’m confused. I don’t think Emmanuel was debating your issue of the 200 note thing. I think he was making a notation about DanB’s “So What” attitude.

Emmanuel, if that’s true, then let me explain about DanB. If I told Dan that the weather here in Florida was beautiful, he’d come back and tell me there’s a hurricane looming around the corner, and that I should just kill myself now to avoid getting swept out to sea.

I don’t think there has been much that Peter has written that DanB hasn’t disagreed with. That’s what makes hanging around here so much fun!

Emmanuel
Jun. 3, 2014 6:18 pm
Reply to  New Jersey Guy

I see… Good to know!

Fred93
Fred93
Jun. 4, 2014 1:37 am

I think point #2 is questionable.

We don’t actually have evidence of “rigor” or “strictness” or even consistency! What we have is a record, so we know how good they have been, and we hope they continue to be as good in the future. We can’t see inside the underwriting box.

I don’t think that situation should be called rigorous or strict. This is simply wrong use of these words.

Fred93
Fred93
Jun. 4, 2014 7:58 pm

I will stand by my position as well.