So-called peer-to-peer online lending first became possible in the United States five years ago, but if you are considering investing money as a lender, it would be wise to wait a couple of years to see how existing lenders fared, according to Ron Lieber’s New York Times article, “The Gamble of Lending Peer to Peer.”
Two companies, Prosper and Lending Club, dominate this market, which began in 2006. Basically, borrowers post a request for funds and explain why they need the money; lenders can invest money into part or all of any loan; Prosper and Lending Club promise to run credit checks on borrowers for the lenders, and collect and distribute monthly payments to the lenders, keeping some money off the top for themselves.
Regulators are very concerned about the whole concept of peer-to-peer lending. The Securities and Exchange Commission made both companies stop taking money from new lenders for months in parts of 2008 and 2009 “to get their regulatory houses in order.” Moreover, these investments are apparently prohibited in over 20 states like Texas, New Jersey, Pennsylvania and Ohio.
Most borrowers apparently use the loans to pay off higher interest credit card debt. Investors’ returns are the interest that borrowers pay, minus the companies’ fee and whatever money the borrowers fail to repay.
When Prosper began in 2006, it reportedly accepted subprime loan applications, and lenders bid, auction-style, for the right to invest, with interest rates falling as more lenders piled in. The default rates caused the company to revise its lending standards and eliminate the auction. “Of all of the loans that Prosper helped originate in its first three years, just over a third went bad.”
One problem is that some borrowers do not provide accurate information about themselves and the companies may not be able to flag and correct misinformation. According to the article, “this sure seems less a bond purchase than a new type of casino game in Las Vegas.”
Still, the peer-to-peer concept is “winning in the marketplace,” at least for Lending Club, which facilitated approximately $14.8 million in new loans last month, more than four times what Prosper did, according to the article.
One money manager, who reportedly invests a tiny fraction of his wealthy clients’ money in only “high-quality” loans that pay, say, 7%, expressed concern that riskiest loans, which pay 12% to 14%, may prove too tempting for inexperienced investors to resist: “I’m not sure they would make the right choices,” he was quoted as saying, adding: “I’d hate to see someone on a fixed income get sucked into that.”
That is why Mr. Lieber says, if you are tempted, wait a couple of years, and see how things shake out for the people who have already lent money. After all, investors should be indifferent to what is “winning in the marketplace.” Lady Gaga dressed up like an egg is winning in the marketplace, but that’s not necessarily a good thing.
Page Perry has over 125 years collective experience representing institutional and individual investors in securities-related litigation and arbitration all over the country. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 40 occasions.