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Suze Orman Money Matters

Suze Orman, Money Matters

Navigating the Risks of Peer-to-Peer Lending

by Suze Orman

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Posted on Friday, June 13, 2008, 12:00AM

Consumers unable to qualify for a traditional loan, or unwilling to put up with the red tape and high costs, are increasingly turning to peer-to-peer lending sites such as Prosper, LendingClub, Zopa, and Virgin Money. Think eBay for personal loans: Instead of matching individual buyers and sellers of goods, these sites bring together potential borrowers and lenders.

I'm all for social networking, but p2p lending is full of risks I don't think many borrowers or lenders fully appreciate, or are paying attention to.

Easy ≠ Smart

The fact that money may be just a few clicks away is indeed tempting. But that doesn't automatically make it a wise move for either the borrower or the lender.

Let's take a look at one of the recent listings that sent my blood pressure up. A gentleman was looking to raise $10,000 for a home down payment via Prosper. The website determined his loan rate after checking his credit file. After a quick crunch of the numbers, Prosper determined he was a lousy credit risk and slapped a 35 percent interest rate on his loan.

No, that's not a typo.

I suppose I shouldn't be surprised that someone with a ridiculous credit profile would have no compunction about trying to borrow money at such a high interest rate. But here's where it gets really insane: Last time I checked, this guy was more than halfway to raising the money he needed. Yep, lenders were ponying up the money for his loan, no doubt enticed by the prospect of earning a 35 percent return on their money.

Think Before You Borrow

Somehow I doubt they took the time to check out Prosper's laudable reporting of the default rate on its loans. If they had, they would've noticed that the higher-risk borrowers have a reported default rate of more than 18 percent. In traditional lending, if you had default rates half that high you'd be out of business.

Then there was the borrower at LendingClub looking to raise a few thousand dollars to pay for a wedding. Her interest rate: 11.25 percent. That might seem reasonable when compared to 35 percent, but it's still a steep price to pay. Moreover, the person was looking to borrow money for an expense that I think should be avoided, not financed.

That's one of my big concerns with these websites: Borrowers can take out loans for just about any project or expenditure. But easy money isn't the same as smart money. Before you sign up to borrow from one of these sites, first ask yourself if you really and truly need to borrow the money, or if it's just money you want to borrow.

Borrower Tips

That's not to say I'm totally against borrowing from these sites. In fact, a good number of people seem to be using the p2p model to intelligently deal with high-rate credit card debt. I saw plenty of borrowers looking for a loan at 10-15 percent or so that they would use to pay off a credit card balance that was more than 20 percent. That can make a good deal of financial sense.

As with all financial deals, though, you need to understand the rules of the road:

• It's all about your FICO score

If you have a score of at least 640 you can qualify for a loan, but it's going to have an astronomical rate. My general advice is that any loan to purchase something or finance a business endeavor that costs you more than 10 percent should be a big warning signal.

Again, don't be blinded by the ease of accessing the money. What you really need to carefully consider is your ability to repay that loan. The one exception to this is if you're looking to use the site to pay off credit card debt; if you can pay off a card that's costing you 25 percent with a p2p loan that runs you 15 percent, that's worth considering. But before you do that, keep reading.

• Borrowing to pay off credit cards won't improve your FICO score

Money you borrow through a p2p site is reported to the credit bureaus as a personal loan. Even if you pay off $15,000 in credit card debt, your credit report will now have a new $15,000 personal loan debt. Thus you haven't gained any ground in reducing your overall debt -- you've simply lowered the interest rate you must pay on the debt.

That's still a solid move in that it should enable you to pay off the debt faster. But don't expect any instant FICO miracles the minute you pay off the credit card balance.

• Fees vary from site to site

At Propser, your annual fee is determined by your credit score, and can range from 1 to 3 percent. Virgin Money doesn't play matchmaker for borrowers and lenders. Instead, it serves as the official middleman for borrowers who already have lenders lined up and both parties want to create a formal agreement.

Virgin has a full lineup of loan servicing agreements for personal and business loans. The cheapest is a $99 Handshake Basic agreement for personal loans between friends and family.

Hiring Virgin Money to draw up the promissory note and a repayment schedule might indeed be worth that money to you. Or you can download a promissory note document form from Nolo for less than $10.

Lender Advice

I totally get the allure here. Your money in the bank is earning 3 percent at the same time inflation is above 4 percent. So the opportunity to lend that money and land a 10 percent, 15 percent, or 35 percent return seems to make a lot more sense. But you need to think about risk:

• It's an unsecured personal loan

If the borrower fails to repay, you're out the money -- you have no recourse. And while the p2p sites are quick to recommend that lenders build a diversified portfolio of loans by making a series of small loans to multiple borrowers rather than risk one big loan to one borrower, if you lend to 20 high-risk borrowers you still have a high-risk portfolio.

One exception to this model is Zopa. Zopa lenders invest in a federally insured 1-year CD that pays a competitive rate -- about 3.7 percent recently. The lender then chooses a Zopa borrower (rates paid by Zopa borrowers vary from 8.5 percent to 16 percent) she wants to help and agrees to use a portion of her investment -- it can be as little as $20 -- to help pay down the borrower's balance.

From the borrower's perspective, the more people they get to help, the lower the total borrowing costs. From the lender's perspective, they may earn more than they could get on a standard bank CD, but at under 4 percent recently, the payoff is more psychic than real profit.

• Look for quality

If you want to lend money, stick with borrowers that have a solid credit rating. Even then, be prepared for a net return that might be a lot lower than the rate you initially see.

For example, using two years of data, Prosper reports an average lender rate for high-quality borrowers of 10.97 percent. But once you factor in the default rate and fees on those loans, the estimated net return for the lender clocks in at 6.85 percent. And those are the average returns for high-quality loans; the numbers begin to look downright ugly as you move down the credit ladder.

• Factor in fees

Sometimes it takes money to lend money. At Prosper, you fork over an annual servicing fee that's equal to 1 percent of your loan balance.

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80 Comments

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  • Salvatore G - Thursday, June 19, 2008, 9:56AM ET  Report Abuse

    • Overall: 3/5

    Making personal loans to strangers is a waste of time.

  • Yahoo! Finance User - Thursday, June 19, 2008, 7:07AM ET  Report Abuse

    • Overall: 1/5

    I love Suze's advice so I was sad to read this article. She did not do her research! I've been a lender on Prosper for almost 2 years. I make an average interest of 10% and have never had a late payment from any of my borrowers. Whats the big problem???? This is a great way to make your money grow.

  • Yahoo! Finance User - Wednesday, June 18, 2008, 8:03PM ET  Report Abuse

    • Overall: 1/5

    ira01 at 1:40PM had a much more interesting write up than Suzie Q. I was considering using Prosper a year ago but am very glad that I declined to do so. I noticed there were a lot of ghetto people with shady loan requests and a whole lot of sob stories. Do you really want to lend your hard earned money to these people you have never met? You read a paragraph about someone and their monthly expenses ( who knows if they are being honest) and you can assess them better than a bank can ? The thing that cracks me up is the section where the person requesting the loan has their friends vouch for them that they are good standing people that pay off their debts. "She be payin dat loan off no problems".

  • Charles - Wednesday, June 18, 2008, 6:13PM ET  Report Abuse

    • Overall: 5/5

    I wouldn't use any like Prosper on a bet! A friend of mine told me about it once and I was a bit skeptical then. It really is a crapshoot. Part of why banks and other lenders can afford to stay in business is because they have staffers to hound folks that get behind on payments. I know - some folks don't deserve to be hounded when the economy is tanking; I'm not talking about those borrowing for valid reasons - like putting food on the table. I'm talking about those who use credit to buy luxuries, with no plans for paying the loans back. The business model for P2P is seductive, but in today's America, with so many folks looking for ways to "game" the system, a Prosper loan is more likely to become a "gift". Good for you, Suze!

  • Alex - Wednesday, June 18, 2008, 1:21PM ET  Report Abuse

    • Overall: 5/5

    I use prosper.com and its not the cash cow that I thought it would be. Its OK. I return about 7.5% on loans after defaults and my portfolio is conservative. This is a good article. The most important point is to check the credit rating of the lender and look at their story and numbers to make sure they make sense. i can always count on good advise from suze

  • Yahoo! Finance User - Wednesday, June 18, 2008, 12:46PM ET  Report Abuse

    • Overall: 1/5

    Suze the conn artist with a big FAT mouth. Hey guys, these clowns don't get paid for this trash. Yahoo lets them post for free and in exchange they get exposure to promote their trash books and other waste. People it's time we start protesting any website, newspaper or TV show who has these clowns. Let them know you refuse to watch or read as long as these conns are featured.

  • Yahoo! Finance User - Wednesday, June 18, 2008, 12:00PM ET  Report Abuse

    • Overall: 5/5

    i can always count on good advise from suze

  • Yahoo! Finance User - Wednesday, June 18, 2008, 8:01AM ET  Report Abuse

    • Overall: 1/5

    how much did you pay to get this job?

  • Yahoo! Finance User - Tuesday, June 17, 2008, 8:21PM ET  Report Abuse

    • Overall: 1/5

    It looks like Suzie did not do a lot of research on Prosper... For example, Prosper does NOT set a person's interest rate. The person sets the interest rate, and lenders bid. The loan is funded at a "market clearing" price, which depends on the number of bidders and the rates at which they are willing to fund the loan. The chances are, the guy asking for $10,000 set his initial rate at 35% as a gamble to attract bidders. He probably hopes that the competing bidders will eventually lower his rate to a reasonable number... Nevertheless, she has a good point. Prosper loans and their risks are ill under stood by the vast majority of investors. Also, the loans themselves, being amortizing, illiquid, and able to be repaid at any point without penalties, (the last point is key) are actually incredibly complex financial instruments. Furthermore, because they are unsecured consumer loans, they are MUCH riskier than even subprime MBS... Buyer beware! Play around with the "performance" tool under the "bid on loans" tab to see how risk is mispriced on Prosper. It will quickly become apparent.

  • Yahoo! Finance User - Tuesday, June 17, 2008, 7:50PM ET  Report Abuse

    • Overall: 1/5

    Read critically, folks. Sounds like Suze didn't actually put a significant amount of her own money into any of these sites. Also wouldn't be surprised if traditional lenders are the ones propagating the stories of how dangerous Prosper is. I've been using Prosper for a little over a year and for me the jury is still out. 20% of my loans are currently late, but the other 80% are making 17-18%, whereas the S&P is down 9% over that same period. If the experiment survives for two more years and the market is flat or worse, then it will have been a good investment for me. Then maybe I will write an article about it and submit it to Yahoo under Suze's name, but I will have to make the article terrible in order to convince them it really came from her.

  • John - Tuesday, June 17, 2008, 4:08PM ET  Report Abuse

    • Overall: 5/5

    A little deceiving, since NO borrower has to accept a 35% rate. Only if you request "automatic" do you get the automatic rate. If you're smart, you set your own rate. I am a Prosper Lender, and THANK GOD I only started with a few thousand dollars and resisted the temptation to increase it. After one year, I have over 100 loans, paying an average of 15% interest (A, B, and C borrowers) and I already have 9 non-payers, including 4 bankruptcies! These are 100 people I selected very carefully, and there were AT LEAST 9 deadbeats already. So if it doesn't get any worse (but it will), I will be netting 6% at the most. It's too late to get my money back, and right now, my best hope is that in 2 years, I will get most of the original investment back, in other words, break even after 3 years. Worst case, I will probably be in negative territory. Maybe I'm just unlucky, but I think Prosper figures are wrong. I don't see how ANYBODY can avoid losing money lending. A good percentage of borrowers are committing fraud, and it's impossible to figure out which ones are the fraudsters until it's too late. Do you really believe that more than 90% of the borrowers will pay off an unsecured loan? I did, but I guess I was naive. And the Prosper "collections" mechanism is pitiful. Proper is closer to a charity than an investment.

  • Yahoo! Finance User - Tuesday, June 17, 2008, 3:10PM ET  Report Abuse

    • Overall: 1/5

    This article is so riddled with factual inaccuracies, it should be pulled. Start at the end: Prosper does not charge lenders a servicing fee based on the loan balance, it is based on repayment amount. And the rate is not 1%, it varies based on the credit rating. Perhaps most laughably, as others pointed out she does not seem to 'get' that people set their own rates and hope for them to be bid down. I really hope this is just sloppy research and she is not THAT stupid. By this measure, people who are listing stuff on eBay with a starting bid of $0.01 are IDIOTS who should instead list their items close to their desired price. P2p DOES have risks and is in need of critical review, but writing a factually inaccurate article is hardly the way to achieve that.

  • Yahoo! Finance User - Tuesday, June 17, 2008, 10:39AM ET  Report Abuse

    • Overall: 2/5

    Prosper does not set 35% rate on the loan, or any other rate. BORROWER sets up an interest rate initially and then lenders bid it down when they compete to invest money.

  • Yahoo! Finance User - Tuesday, June 17, 2008, 9:55AM ET  Report Abuse

    • Overall: 4/5

    I have read so many articles about Prosper that seems like they were written by Prosper's PR department. It's actually quite refreshing to read an article that talks about the negative aspects of Prosper.

  • zzzzzzz - Tuesday, June 17, 2008, 9:40AM ET  Report Abuse

    • Overall: 1/5

    Suze, please know how a site works before you start ranting about it. It's true some lenders join thinking they'll make 30% on loans with poor credit and never have a default, but that is an unrealistic expectation. People should know the risks, and know that the Prosper collections service is sub-par. "Even if you pay off $15,000 in credit card debt, your credit report will now have a new $15,000 personal loan debt. Thus you haven't gained any ground in reducing your overall debt -- you've simply lowered the interest rate you must pay on the debt." Wow. Are you saying that lowering the interest rate on $15,000 of debt is a bad idea? And paying if off over a 3 year term instead of just paying the minimum payments is a bad idea? Seriously, check yourself.

  • Lizzi - Tuesday, June 17, 2008, 12:14AM ET  Report Abuse

    • Overall: 1/5

    Suze...this is not a good topic for you. Stick to what you know. Prosper doesn't select the starting rate for borrowing -- the borrower does (35% is now the maximum rate allowed, unless your state maximum is lower). Some borrowers choose to start at high rates because the higher starting rate with good credit tends to get bid down further (the competitive spirit) -- and then after all of that, if it's not low enough for the borrower the borrower can still choose to opt out. As a lender, the 'best quality' on Prosper doesn't make sense. Those loan rates tend to run for about what I can get elsewhere (in safer investments). And anyone with a quality credit history and is intelligent financially is not going to get a loan from Prosper (my credit isn't great and my rewards credit card currently has a rate of 7.5% and free cash advances-- why would I use Prosper to get a fixed 10-15% rate loan, where I'm paying 1 % upfront?? You stick to telling people to pay off their credit cards and not blow their money on stupid wants (and to hopefully figure out that most of their 'needs' are really wants), and I'll stick to making money and not reading anything of yours, because it doesn't apply to the fiscally responsible (I have more in my 401k than my baby-boomer parents combined).

  • Yahoo! Finance User - Tuesday, June 17, 2008, 12:13AM ET  Report Abuse

    • Overall: 3/5

    Hey, if you're going to nitpick Suze's English, at least get it right. Psychic can be an adjective meaning that which pertains to the soul or mind or that which is primarily mental rather than physical.

  • Yahoo! Finance User - Monday, June 16, 2008, 11:31PM ET  Report Abuse

    • Overall: 1/5

    Wow, Suze Orman is garbage: "Prosper determined he was a lousy credit risk and slapped a 35% interest rate on his loan" - Prosper functions, as you say, like Ebay, where the final rate is determined by the market's willingness to take on the risk of that lender, the website didn't 'slap anything on him', that was the rate he was willing to take. Many borrowers offer to take such high rates with the hope of getting them bid down, just as many listers on eBay list their items at $0.01 to start, hoping the listing will attract additional attention. Yes, borrowers should beware borrowing at such high rates - but respectable authors shouldn't incorrectly take an example out of context to make it fit their lousy column. "The payoff is more psychic than real profit" - I didn't realize payoffs help one predict the future, don't you mean psychological?!???! I can't believe anyone pays this woman for her so called advice - save your money, spend an hour at a library or a computer doing your own research - you have a much better chance of learning something truly helpful (and accurate).

  • Yahoo! Finance User - Monday, June 16, 2008, 11:23PM ET  Report Abuse

    • Overall: 2/5

    This article was very depressing to read as it clearly illustrates that personal responsibility and the overall intelligence of the general public has and will continue to precipitously decline with the passage of time. People who have to take out a $5K loan from a p2p lending in order to have a wedding shouldn't be allowed to procreate as they obvious can't afford to have children if they can't even come up with $5K for a wedding.

  • __A_YAHOO_USER__ - Monday, June 16, 2008, 10:58PM ET  Report Abuse

    • Overall: 5/5

    Great advice Suzie. I just want to know if that hunky sidekick of yours is gay and available. Whataman!

  • Yahoo! Finance User - Monday, June 16, 2008, 9:48PM ET  Report Abuse

    • Overall: 4/5

    Suze Orman did her homework and said right to the point. I had impression that she always says something obvious. This article has changed my view.

  • Yahoo! Finance User - Monday, June 16, 2008, 9:03PM ET  Report Abuse

    • Overall: 1/5

    Lacking

  • dipstick - Monday, June 16, 2008, 8:14PM ET  Report Abuse

    • Overall: 4/5

    at a girl susie

  • RobertM - Monday, June 16, 2008, 8:04PM ET  Report Abuse

    • Overall: 2/5

    Why would anyone want to lend money to a stranger??? People are too stupid for words.

  • Kristen - Monday, June 16, 2008, 7:04PM ET  Report Abuse

    • Overall: 4/5

    Thanks for the recommendation of Nolo. I have a friend who is starting a chiropractic business and banks are reluctant to loan for that purpose, charging high rates when they do. I know the guy and would feel comfortable lending to him, knowing he is above reproach and would pay the money back. Paying mere $10 for a professionally-drawn-up contract to document the loan sounds like a good investment.

  • none - Monday, June 16, 2008, 5:38PM ET  Report Abuse

    • Overall: 1/5

    what she fails to tell you is; as a lender your risk can be mitigated through diversification. Keep your investment in each loan no greater than $50 to $100 and only lend to the lower risk borrowers. This is the lending business, it's a numbers game. A certain percentage are going to default.

  • Yahoo! Finance User - Monday, June 16, 2008, 5:23PM ET  Report Abuse

    • Overall: 1/5

    What absolute dribble. I wonder why this was even an issue being brought up. Did someone try to get rich quick and get less than they expected?

  • Michael Tsen - Monday, June 16, 2008, 5:10PM ET  Report Abuse

    • Overall: 5/5

    Suze usually have already known useless advice but this time, it hits target. It's personal finance so it makes sense. These p2p lending are cool at first like ebay at first, but it wores out. You will have criminal dress in suit, identity theft, and when you lend them money, you lose.

  • Yahoo! Finance User - Monday, June 16, 2008, 4:25PM ET  Report Abuse

    • Overall: 1/5

    Suze (or her team of minions) needs to do more research before writing these things -- Prosper does not assign interest rates to borrowers. Borrowers choose the auction's starting interest rate on their own, and many borrowers strategically set their starting interest rate high to attract bidders (same way you start the bidding on eBay at $1 even though you're selling a car). In the event that the ending interest rate on the borrower's auction is too high for their liking, the borrower can walk away from the loan with no cost or penalty whatsoever.

  • Yahoo! Finance User - Monday, June 16, 2008, 4:23PM ET  Report Abuse

    • Overall: 1/5

    sounds like the latest easy money by fraud, and people just give a borrower money. come on people, you can't even really trust family. i'm sure many career criminals will find their way there if they already haven't.

Showing comments 6-35 of 80<< PreviousNext >>
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