Dave Ramsey is one of the most famous personal finance educators in the country. He has written several books, has a nationally syndicated TV and radio show, a newspaper column, and conducts what are billed as the largest live events in the nation on personal finance. He has an extremely dedicated following of people who listen closely to his advice.
So I was curious when I noticed on the weekend this newspaper column where someone asked him about peer to peer lending as an investment. I didn’t think he would be all that positive about it but I assumed he would at least provide a reasoned answer. I was wrong. Here is an excerpt of his advice:
Sorry, but as an investment strategy I think this kind of thing is pretty stupid. Most of these kinds of loans are not collateralized, which means they’re not checked out. I mean, would you loan someone money without really getting into their business and knowing something about them first?
While everyone is entitled to their opinion this paragraph has one glaring inaccuracy. It is true that most of these loans are not collateralized (actually on Prosper and Lending Club no loans are collateralized), what is incorrect is his explanation that a collateralized loan means “they are not checked out”. I have no idea why Ramsey would say such a thing because that is just plain wrong.
What a Collateralized Loan Really Means
A collateralized loan means a secured loan. In fact, the word collateralized shouldn’t really be used here (it may confuse people with collateralized debt obligations which are different) – it should be called a collateral loan or better yet a secured loan.
Some loans, such as home or car loans are secured by assets (also called collateral). This is why if you default on your home loan a bank isn’t left with nothing, they are left with an asset that they can then sell. Same goes for car loans. It has nothing to do with whether the loan has been “checked out”. Loans on Prosper and Lending Club are like credit card loans – they are unsecured (not collateralized) meaning if a borrower defaults on a loan then the lender can be left with nothing.
The Same Old and Tired Argument
Let’s take the last sentence in Ramsey’s response. I see this argument all the time from people who don’t understand peer to peer lending. Would you lend money to someone if you know nothing about them? Of course you wouldn’t. But if this same person has filled out a detailed loan application, gone through a sophisticated screening process, had their credit report pulled and possibly even had their income verified then what do you say? This is the reality of peer to peer lending but that, of course, is not mentioned in his response.
I am one of the first people to admit that there is risk in peer to peer lending. Unless you are very lucky you will have defaults. But the vast majority of borrowers pay their loans on time and the vast majority of investors are making good returns on their investment. Doesn’t sound that stupid to me.
I Have Nothing Against Dave Ramsey
Now, let me be clear, I know very little about Dave Ramsey, I have never read any of his books nor seen his TV shows. So I really have nothing against him at all. Most of what I know about him comes from reading other personal finance blogs and from my brother-in-law. He has read his books, been to a live event and has implemented many of Ramsey’s debt reduction principles into his life and is far better off for it. We actually had a long chat about the Ramsey philosophy just this past week.
To say an investment is “stupid” and then give an inaccurate reason to justify your opinion is irresponsible of Ramsey to say the least. I am sure that Dave Ramsey understands what a “collateralized loan” means and that it was a miscommunication between him and the person who published the column. But false information should be corrected and I hope Ramsey will do just that. I also recommend he attend my free webinar on peer to peer lending this Thursday. Sounds like he would learn something.