Hungry for high interest rates?

By Elizabeth King Humphrey

The best social lending sites for top earnings.

You’ve got a chunk of money to invest at a social lending site and you’re gunning for the highest interest rate possible. But how to pick the right site and navigate your way to a fat return?

First, avoid sites that tend to favor the borrower. (Translation: low interest rates for lenders.) For instance, unless a trusted colleague has agreed to pay you 10 percent on a business loan, Virgin Money USA is not a good bet for high earnings. It’s mainly a service site for formalizing low-interest loans between family and friends.

Student loan sites like Fynanz.com pay lenders decent interest rates, but payments can be deferred for years. Again, not the fastest way to a good return.

Finally, two social lending-like sites, MicroPlace.com, an online brokerage geared toward microfinancing the poor, and Zopa.com, both guarantee their loans, a compelling reason to consider them. You certainly might sleep better at night knowing you can’t lose your principal. But guess what? Interest rates are in the cellar at zero to 4 percent.

Best sites for high rates
So where to go for some potential high rolling? Your best bets are The LendingClub.com, which pays lenders an average of 11.28 percent, and Prosper.com, with a 10.21 percent average (based on the latter’s Aggressive Portfolio Plan).

Newcomer Loanio.com, up for just two weeks when we posted this story, promises to be another good destination for lenders looking for a high rate. Though it’s too early for dependable averages, the interest rates on the 33 loans posted on the site in early October ranged from 5 percent to 30 percent.

Factor in fees
Social lending sites make their money by charging somebody , the borrower, or some other party. If it’s you, the lender, that means you might not be making the alluring interest rate being advertised on the site.

Prosper used to waive lender fees for borrowers with an AA rating. But now all three sites charge lenders a flat monthly processing fee of 1 percent of their borrower’s payment.

As a result you’ll lose a small chunk of your earnings to the lending fee, although not the full 1 percent because of amortization over the three-year loan. For instance, a $100 loan earning 10 percent effectively will be lowered to about 9.38 percent.

Expect defaults
In a perfect world all social borrowers would pay back every cent plus the agreed-upon interest. Unfortunately, dealing with defaults is part of the social lending game. These, too, can cut into your earnings from a little to a lot depending on your choices and pure luck.

Talking averages, the Lending Club’s default rate is about the same as the national default on prime loans, or 2 percent. If your loan were set at 13.80 percent, then, you might actually make only 11.80%, not counting the service fee. The lender’s service fee would further lower your net earnings to a little over 11 percent.

At Prosper the net default rate on all loans since the site’s launch is 3.83 percent.

As social lending sites mature and attract more users, you can probably expect the default rate to tick higher. There’s not much you can do about it, except choose your borrowers as wisely as possible.

Spread the risk

Borrowers can take out loans up to $25,000 at Prosper, LendingClub and Loanio. If you have that much to invest, it might be tempting to put all your eggs in one basket to save the hassle of shopping around, especially if you fall in love with a particular borrower’s story. But don’t.

Most social lending sites recommend spreading your money thinly; $50 is the smallest amount you can lend at Prosper and Loanio. The Lending Club requires a total investment of $500 but you can lend as little as $25 per borrower.

Think of it as spreading your money around multiple mutual funds, only thinner. The more you diversify, the lower your risk and the higher your potential net earnings.

Going for the highest rate or not
Unlike at Prosper and Loanio, lenders who choose the LendingClub have no control over how much their loan pays. The site assigns the interest rates paid lenders based on the borrower’s credit rating. Interest rates range from 7.37 percent to 18.61 percent. The higher your tolerance for risk, the higher the interest rate you should choose.

The good news for lenders is that the LendingClub accepts only prime borrowers with credit ratings of at least 640. The Lending Club uses other factors such as debt-to-income ratio to assign interest rates. So a loan with a high interest rate at LendingClub might be safer than one at another site.

Almost anyone can borrow at Prosper and Loanio, which means you’ll need to scour borrower profiles yourself when balancing high rates against risk.

But let’s say you want a high rate, no holds barred. Look for borrowers who are offering to pay the highest rates  15, 20, or even 30 percent – and bid a few points lower than their requested rate. You might be forced out of the auction if undercut by another lender, and of course this strategy exposes you to the poorest credit risks. But it’s one way to achieve interest rates two to three times that of a CD.

For conservative investors, both Prosper and the Lending Club offer a portfolio feature that automatically funnels your money into the safest choices.

But everything is a tradeoff. The estimated return earned by Prosper’s Conservative portfolio plan? 5.78 percent.

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