I'm conservative with money, so lending to strangers on a Web site called Prosper might seem out of character. But when I was going over my investments this past winter, my well-balanced portfolio of mutual funds wasn't doing so hot, and my once-high-interest savings account seemed less and less appealing as rates kept falling. Since Prosper's founding two and a half years ago, peer-to-peer lending, as it's known, has been gaining respectability, and I liked the idea of helping people to expand businesses or pay off credit cards with exorbitant rates. I figured I could get at least a smidge more income on Prosper than from my boring, reliable bond fund, let alone a savings account, even if—as seemed likely—a loan I made defaulted.
And so, in January, I transferred a few hundred bucks to Prosper. I created a set of rules for what I'd bid on and how I'd structure my mini-portfolio. But even as I started to acquire loans with double-digit interest rates in Prosper's online auctions, I couldn't help asking myself: Was I nuts for thinking I could pick the "right" loans? What made me believe I understood the real risks of bidding on a stranger's debts?
The idea behind Prosper, and a handful of sites like it, is to allow average folks to lend to other average folks strapped for cash. It's lending for the little guy, enabled in large part by technology that allows bite-size payments to be processed online profitably.
The concept dates back to 2005, when Prosper, along with a similar venture in London called Zopa, set up shop. Prosper founder Chris Larsen started the site after selling his previous consumer-lending company, E-Loan, to Banco Popular parent Popular (BPOP) in 2005. (Larsen is one of the good guys of consumer finance: He used his position at E-Loan to push for disclosure of credit scores and analysis to consumers.)
By the time I decided to become a lender, peer-to-peer lending had grown substantially. Prosper's loan volume has surpassed $130 million, and rivals such as Lending Club, Virgin Money USA, and Loanio have gotten in on the action or plan to do so. In the overall $2.5 trillion consumer-credit market, this kind of lending is a flyspeck, but it has the potential to change how lending is done. It's projected to grow fast: Online Banking Report, a monthly publication, has estimated that originations could hit $9 billion by 2017.
For me, there was no question which site I'd pick. Prosper was the leader, and I trusted Larsen, whom I'd spoken with before in the course of writing articles. I'd actually registered with the site years ago and then ignored it, happy as I'd been with my other investments.
Prosper spent years getting regulatory clearance. But for individuals, putting money to work is simple. It works, essentially, like eBay (EBAY). Prosper acts as an intermediary—technically, it makes the loan and resells it to you—and takes a sliver of profit from both sides of the deal. Borrowers list loans, eBay-style, of $1,000 to $25,000 and choose their interest rates. When Prosper was set up, its borrowers faced a patchwork of maximum rates dictated by state usury laws. But FDIC-insured banks aren't subject to state usury rules, so when Prosper partnered with WebBank in April it could permit borrowers to go to a max of 36% in the states in which it's approved, save Texas. (Prosper is not approved in South Dakota.)
A lender bids, in amounts between $50 and $25,000, at rates as high as the posted rate. Say a borrower posts for a loan of $15,000 at 15%. I might bid for $50 of that loan at 12%. I'll get my slice of the loan at 15% if there aren't many bidders. But if the loan gets fully funded and more lenders want it, the rate will be bid down until bidding closes. In that case, if the rate goes below 12%, I'll lose the loan unless I bid again.