I received a pleasant email message from one of the marketing people at Prosper.com and was rather startled when I checked out the site and found out that what they’ve created is a marketplace for people seeking loans, and other people seeking unusual investments.
It’s hard to imagine how this isn’t some huge scam magnet and I even wonder about the legal implications, tax consequences and, yes, even whether Homeland Security would have concerns. So I asked them some questions, and Prosper’s Chief Technology Officer John Witchel was kind enough to answer them…
Q: How did you come up with the idea behind Prosper.com?
The original idea behind Prosper was from our CEO, Chris Larsen. He had founded E-LOAN so he knew quite a bit about credit. And like all ideas he started with the most basic question: “Why?” Why is credit so
expensive? Why is it so inflexible? Why is it so hard? And it just went from there.
Q: Can you step us through exactly how someone would apply to have you advertise a loan they sought, what interest rate they’d offer, how they’d get financed, and how they’d pay back the individual investors?
There are three pretty good “How it works” pages that have some nice pictures (so I won’t paste them in here, but here are the links: How It Works, About Borrowing, and About Lending)
And our FAQ gets into the details too: Get Started FAQ
Q: Person-to-person lending online? I’d be paranoid about scams and rip-offs. Tell us how you sidestep that issue?
Hmm. Well Borrowers get the money, so I assume you’re thinking about it from the lender’s point-of-view.
Here are the excerpts from the FAQ that describe identity verification and diversification (which are the two main mechanisms to deal with the issues I think you’re getting at (let me know if I missed it)):
For the safety and security of the marketplace, it is important that Prosper guarantee that all individuals participating in the marketplace are 1) a real person, and 2) the same person they say they are. To this end, Prosper takes extra care in verifying the identity of all borrowers, lenders, and group leaders.
When you start any process on Prosper that involves the exchange of money, your identity will be verified against data from credit reporting agencies and other identity and anti-fraud verification databases. You will be required to provide your name, date of birth, Social Security number, address and telephone number. Based upon this and other data, Prosper will verify your identity.
The level of confidence we need to assign you to different roles may vary by role. Therefore, you may be required to prove your identity for each new role you request.
There are no guarantees that your loan will be repaid. We try to give lenders as much information as possible about the credit worthiness (or “credit grade”) of the borrowers on the site, their debt burden (known as the “debt to income ratio”), and the expected default rate of a borrower with their credit grade, which is based on historical data from Experian, one of the three major credit reporting agencies.
The way to ensure a good return on your investment is to diversify your lending-create a standing order to place bids on many listings, and spread your risk across many borrowers. If you make 100 loans to B-rated borrowers at 8%, and B-rated borrowers have an expected default rate of 1.8%, then you might have 2 borrowers default, which would lower your return by 2%. After annual lending fees of 0.5%, this would give you an annual 5.5% return overall. Learn about diversifying your lending with standing orders.
Q: How should people that lend spread their risk?
Because Prosper allows lenders to bid small amounts on all or part of loans, it is easy for lenders to create well-diversified portfolios. Using Prosper’s standing order feature, lenders can efficiently diversify their portfolio by automatically funding listings that reflect their pre-defined criteria.
For example, a lender can bid as little as $50 on any loan listing. To diversify their portfolio, a lender might want to spread an overall investment amount of $10,000 among several loans. Learn about diversifying your lending with standing orders.
Q: What happens if a borrower does not repay their loan?
Borrowers who miss payments on Prosper face the same consequences as they would if they miss a payment with any form of bank credit including the reporting of late payments to the credit bureaus. Borrowers also incur late fees, which are collected by Prosper and passed onto the people that loaned the money.
When a borrower’s payment is late, Prosper communicates directly with the borrower to encourage repayment. After 15 days, Prosper notifies the group leader of the late payment and that the group’s reputation is at risk. After 30 days, Prosper engages a nationally-licensed collection agency, giving borrowers 90 days to bring the account to current. At 120 days past due, the loans are sold to a debt buyer. At that point, the borrower’s credit report is negatively impacted with a default, they are banned from the platform, and the group’s reputation is negatively affected. Learn about what happens to borrowers who are late with payments.
Q: How about a few success stories of people who have raised enough for a meaningful change in their lives? How many loans have you made at this point, and how many have been paid back?
We’re not disclosing hard numbers yet, but we’re off to a great start. If you browse the site (start here) you’ll get a good sense of who’s using the site for what purposes. If you see a little green check box near the listing that means they’re “in the money” (i.e. they have enough money to create a loan.)
Q: Speaking of financials, how does Prosper get paid for these transactions?
Here is our fee schedule: Prosper fee schedule.
If you’re making loans or acting as the middleman, aren’t there federal laws and restraints on this sort of activity? If nothing else, surely there are issues of money laundering and other Homeland Security issues?
Yes, there are many compliance issues. We believe we have built a model that will satisfy all the state and federal agencies that have jurisdiction over our business.
Q: You have “credit grades” that in essence are assigned risk values for a given loan. How do you calculate those?
Here’s our blurb on that: calculating borrower credit grades.
Do people seeking loans have to put up some tangible property, to “secure” their loans, before they can proceed? No. All loans are unsecured.
Q: This seems like an interesting vehicle for charities to raise money: do you work with non-profits who might not plan on paying back loans? Or those that might offer a loan but want a zero-percent interest rate?
Q: A quick scan of the featured loans suggests that the average is about $5000 at 10% interest. Is that about right? How does that compare to a typical bank or financial institution loan?
Sorry, I can’t give you answers on what’s average or competitive. You’ll have to draw your own conclusions. But we’re working to make that information more visible on the site.
Q: Finally, what about the tax implications. Does prosper report all transactions to the Internal Revenue Service and U.S. Treasury Department?
Q: Thanks for your candor. Any last thoughts on p2p loans and the future of financial transactions in the online world?
Nope. We have high hopes for our site, but it really depends on people like you who ask hard questions. We try to be forthright in what we’re doing.
Thanks for your direct answers and information, John. I’m not sure I’m ready to utilize your system for my next loan, but it’s darn interesting!