Your guide to peer to peer lending

Dave Ramsey Doesn’t Understand Peer to Peer Lending

by Peter Renton on July 11, 2011

Dave Ramsey is one of the most famous personal finance educators in the country. He has written several books, has a nationally syndicated TV and radio show, a newspaper column, and conducts what are billed as the largest live events in the nation on personal finance. He has an extremely dedicated following of people who listen closely to his advice.

So I was curious when I noticed on the weekend this newspaper column where someone asked him about peer to peer lending as an investment. I didn’t think he would be all that positive about it but I assumed he would at least provide a reasoned answer. I was wrong. Here is an excerpt of his advice:

Sorry, but as an investment strategy I think this kind of thing is pretty stupid. Most of these kinds of loans are not collateralized, which means they’re not checked out. I mean, would you loan someone money without really getting into their business and knowing something about them first?

While everyone is entitled to their opinion this paragraph has one glaring inaccuracy. It is true that most of these loans are not collateralized (actually on Prosper and Lending Club no loans are collateralized), what is incorrect is his explanation that a collateralized loan means “they are not checked out”. I have no idea why Ramsey would say such a thing because that is just plain wrong.

What a Collateralized Loan Really Means

A collateralized loan means a secured loan. In fact, the word collateralized shouldn’t really be used here (it may confuse people with collateralized debt obligations which are different) – it should be called a collateral loan or better yet a secured loan.

Some loans, such as home or car loans are secured by assets (also called collateral). This is why if you default on your home loan a bank isn’t left with nothing, they are left with an asset that they can then sell. Same goes for car loans. It has nothing to do with whether the loan has been “checked out”. Loans on Prosper and Lending Club are like credit card loans  - they are unsecured (not collateralized) meaning if a borrower defaults on a loan then the lender can be left with nothing.

The Same Old and Tired Argument

Let’s take the last sentence in Ramsey’s response. I see this argument all the time from people who don’t understand peer to peer lending. Would you lend money to someone if you know nothing about them? Of course you wouldn’t. But if this same person has filled out a detailed loan application, gone through a sophisticated screening process, had their credit report pulled and possibly even had their income verified then what do you say? This is the reality of peer to peer lending but that, of course, is not mentioned in his response.

I am one of the first people to admit that there is risk in peer to peer lending. Unless you are very lucky you will have defaults. But the vast majority of borrowers pay their loans on time and the vast majority of investors are making good returns on their investment. Doesn’t sound that stupid to me.

I Have Nothing Against Dave Ramsey

Now, let me be clear, I know very little about Dave Ramsey, I have never read any of his books nor seen his TV shows. So I really have nothing against him at all. Most of what I know about him comes from reading other personal finance blogs and from my brother-in-law. He has read his books, been to a live event and has implemented many of Ramsey’s debt reduction principles into his life and is far better off for it. We actually had a long chat about the Ramsey philosophy just this past week.

To say an investment is “stupid” and then give an inaccurate reason to justify your opinion is irresponsible of Ramsey to say the least. I am sure that Dave Ramsey understands what a “collateralized loan” means and that it was a miscommunication between him and the person who published the column. But false information should be corrected and I hope Ramsey will do just that. I also recommend he attend my free webinar on peer to peer lending this Thursday. Sounds like he would learn something.

{ 25 comments… read them below or add one }

Peter July 11, 2011 at 11:13 am

I’m a big Dave Ramsey fan, and he has helped our family to better our financial situation as well. In some respects though I think Dave has some pretty strong opinions about certain topics that I tend to disagree with a bit. P2P lending is one of them, as well as the fact that he uses NO credit whatsoever – whereas i think there is such a thing as responsible use of credit. I think i understand to some degree that he has to dumb his message down to the lowest common denominator and stay consistent to it, but as far as this point I ‘ll have to agree to disagree with Dave. I’m wondering if it could just be part of the anti-p2p bias that a lot of people have after it had a rough start a couple of years ago?

Investor Junkie July 11, 2011 at 11:20 am

Dave Ramsey, while might be decent for debt reduction, is NOT a good investor. His main advice for investing is hiring an expensive professional.

For some additional insight into some of his bad advice visit:

http://badmoneyadvice.com/category/dave-ramsey

Glenn July 11, 2011 at 11:31 am

Peter. Great response. I hope you post your response as a comment on his posting as well.

Peter Renton July 11, 2011 at 11:54 am

@Peter, I read with interest your interaction with Dave Ramsey recently. I think he does provide a great service for people who have only some financial literacy. But he does have some extreme views such as the NO credit thing. Mind you that is probably good advice for 75% of the population.

My guess is that Dave Ramsey read a negative article about peer to peer lending a few years ago when defaults were high and decided it was a bad thing. And he hasn’t bothered to see if anything has changed.

@IJ, That is the sense I am getting. Maybe he should stick with the debt reduction advice and skip the investment stuff. They are very different after all.

@Glenn, Thanks. I tried to make a comment on the article itself but PostBulletin seems to have a big in their registration process ans I was never able to register to make a comment.

Bilgefisher July 11, 2011 at 12:00 pm

I have to agree with Investor Junkie. His principles are very elementary and great for folks who don’t know how to control their spending. Beyond that, his advice can lead to a veeerry slow path to wealth in my opinion. I don’t want to die wealthy. I will become wealthy while I still have the life to enjoy it. His books tell you to put your money in a good 12% return money market account. First, find me a solid 12% return money market account and I’ll find you a leprechaun or a ponzi scheme. 2nd you have zero control over how that money is invested. I have a heck of a lot more control in p2p than any money market run by some guru manager who predicts the future about as well as the weatherman can predict the next snowfall.

I have no illusions of getting rich through p2p. My money is there because it offers a far better return than any bank, stock fund, or cd can provide. I can actually beat inflation with p2p. When the time comes to reinvest that money, it will go into my business where I can get far better returns.

Here’s my simple question for Dave, “Did you make your money off putting x dollars away, or did you make your money of selling books?”

I guess that’s a bit of a rant, but I am tired of the Dave, Robert and Suze’s of the world that make their money off marketing while telling everyone else an entirely different way to invest. Then they have the gall to criticize any form of investment that doesn’t fit into their perfect little world. Follow guru’s at your own risk and peril.

Jason

gharkness July 11, 2011 at 12:03 pm

I also think Dave is good at what he does – but giving advice on P2P lending just isn’t one of those things.

It appears that public figures like Mr. Ramsey tend to get “stuck” on a patter, and in his case, that “patter” lacks information on P2P lending (though why he is so misinformed, I can only guess).

Most of the people who use Dave’s advice do so because they are deep in debt. Really, they are not the kind of person who should be utilizing a somewhat risky form investment. Yes, I said it: Risky.

You KNOW it’s risky, else the prospective returns would be low. It’s the oldest rule on the books: If you want a high return investment, you MUST accept risk. I’m down with that, but some people aren’t (and shouldn’t be). I just think Dave was answering a question that is really out of his normal realm of advice, and it bit him.

Peter Renton July 11, 2011 at 12:28 pm

@Bilgefisher, I had read that 12% number in an article and I thought it couldn’t be true that he said that. Is he stuck in the 1970′s? If he is sticking to his 12% number then he really should check out p2p lending – because I very much doubt he will be able to get that kind of return in any of the major asset classes over the long term.

@gharkness, You are right – p2p lending would be a bad investment decision for anyone in a lot of debt. Heck, any investment outside of building up an emergency cash account and paying off debt would be a bad decision for such a person. But this person was asking Dave Ramsey about investing so there is likely a small portion of his followers who have some money to invest. Yes p2p lending is risky, but I also happen to believe it is the best risk/reward investment available today.

Moe July 11, 2011 at 12:32 pm

I think Dave’s system is realy brilliant, like if your’e in debt stop spending money you don’t have and pay off your debt… duuuuu. And first pay down the loan with the highest interest rate, wow who would have thunk…

Moe July 11, 2011 at 12:48 pm

Peter, I think you left out a major point. In my eyes the main difference between P2P lending and lending to a stranger or even family, is that the borrower is fully aware that his non-payment will get reported to the credit bureaus, and will also eventualy be turned over to collections further ruining his credit score. Just like people pay the credit card companies just to maintain good credit, so will they pay these loans. In other words, the collateral of the loan is the borrowers credit score.

Shawn July 11, 2011 at 1:10 pm

Since Dave typically handles debt reduction advice and not investments, I would be curious to hear his advice on using P2P to get loans and if he would recommend any of his listeners/readers get a loan through P2P.

Peter Renton July 11, 2011 at 1:51 pm

@Moe, Good point about the credit score. I hadn’t thought of the credit score as collateral but for people who are motivated to keep a good score I can see how it acts as such. Unfortunately there are many people who either don’t care or are having such problems that the credit score is the least of their worries. But I agree that many people probably take this into consideration.

@Shawn, Now that would be a good question to pose to Dave Ramsey. If you can get a loan at 12% to pay off an 18% credit card balance that seems like a no-brainer to me. But who knows – Mr. Ramsey are you out there?

Moe July 11, 2011 at 4:24 pm

@Peter, the people who don’t care about their credit score, mess it up way before they get to a score that will let them borrow. Someone who has a good score is only because he cares about it.

Dan B July 11, 2011 at 6:20 pm

Dave Ramsey is 90% marketing & 10% product. Therefore he is a perfect fit for his target audience……………..need I say more.

Peter Renton July 11, 2011 at 7:19 pm

@Moe, That is probably true but there are also those people who, even with a half decent credit score, skip out without making a payment. I would have to think that many of those people don’t give a hoot about their credit score. But of course, that is a relatively rare occurrence.

@Dan, I think your percentages are about right. And part of that marketing seems to be a motivational message that really resonates with people. In many ways he is no different from other PF gurus (such as Orman or Kiyosaki), but he does seem to motivate people to keep buying his stuff which will hopefully lead to getting rid of their debt.

KenL July 11, 2011 at 8:53 pm

The only things I’ve read about Dave Ramsey have been in Prosper and LendingClub loan descriptions. In many of those descriptions the borrowers seem pretty excited about getting the “snowball” rolling. It seems these are people who know very little about personal finance and would be very unlikely to invest anyway. So actually, I partially agree with Ramsey, p2p lending is a bad idea for his core audience. However, if they can ever pay off their dept [sic] and gain a better understanding of personal finance, only then should they consider p2p lending.

Charlie H July 11, 2011 at 9:33 pm

In Daves defense the 12% number is NOT a money market yield number. The 12% number is a 30 year average yield of a good growth fund.

I still think that 12% is just a tad bit of a high expectation… then again being 30 I started investing in my 401k ~ 8 years ago. 8% seems to be a more reasonable growth target.

Bilgefisher July 12, 2011 at 7:38 am

Dan, you summed it up perfectly.

KenL July 12, 2011 at 10:23 am

Charles,
Your absolutely right, at least for now a 12% long term return on any fund seems ridiculous (but with P2P lending a 12% return is very possible :) ).

Peter Renton July 12, 2011 at 11:00 am

@KenL, I have been reading a bit more of Dave Ramsey’s stuff in the last day and while he does focus on debt he certainly does also talk about investing. He talks about six baby steps to paying off debt. But it seems that he doesn’t want his followers to crank up their investing until their house is paid off (baby step 6). But he didn’t mention that in his answer to the question – he just said p2p lending was a stupid idea – period.

@Charles, Thanks for the clarification. I thought it was strange that he talked about 12% money market accounts when we haven’t seen that since the early ’80′s. Taking a long time horizon I can think of no asset class that has returned 12% over say a 20 year period. P2P lending has the potential to do that but we are a long way from a 20 year track record.

Charlie h July 12, 2011 at 3:54 pm

What have the cities and capital ones of the world managed for gross margins on their consumer debt portion of their lending portfolio? That number will like give the upper bound range for roi for p2p lending. Thoughts?

S. Mart Erthanu July 15, 2011 at 10:25 pm

I think it’s interesting that you all are so brilliant when it comes to investing, and that Dave just, “doesn’t get it,” when it comes to P2P lending.

And for the smart guy that asked whether or not he’d advise P2P as a way to get a loan, you’re one dense SOB.

“He’s all wrong on investments. He should stick to debt reduction.”

The blind leading the blind. I’m glad to see you all fully understand the principles Dave offers before you make ignorant statements in their regard (PLEASE READ WITH INTENDED SARCASTIC TONE). It’s too bad Dave isn’t beyond a decamillionaire to prove that he has a little understanding when it comes to investing. Wait…

If I had a dollar for every time some jack wagon made a statement about how not using credit is right for 75% of everyone – excluding your, because you’re so freaking smart – I’d be more loaded than I already am. I digress… the line is very simple: if you play with snakes, you will get bitten. You’re a slave to your lender. I don’t use credit. At all. I’m not missing out on anything but risk.

If you don’t fully understand the words that are coming out of Dave’s mouth, you really don’t have the credibility to make judgement against him. Good luck, suckers.

Peter Renton July 16, 2011 at 7:31 am

@Charlie, I am not sure what the gross margins are on the debt portfolio of Citi or Capital One. Whatever they are you know that there have some customers where they make a fantastic ROI and others where they lose money. My goal is always to try and get an above average return by avoiding the people that cause losses. Obviously there is an upper limit to this approach but I have to think that upper limit is in the 15-18% range I would be delighted to have an ROI like that.

@S. Mart Erthanu, You may well be smarter than everyone here although it is difficult to tell from just one comment. Dave Ramsey may know a great deal about investing in general, I was merely pointing out some factual inaccuracies in his statements about p2p lending.

Most of us here spend a great deal of time studying p2p lending so I think it would be fair to assume that we know far more than most finance and investment experts (including Dave Ramsey, Suze Orman or Warren Buffet for that matter) who only have a passing knowledge of p2p lending. Does that mean we are smarter than those people? Of course not. We just happen to have spent a lot of time studying a small investment niche.

We are all entitled to our opinions and you have made yours very clear.

Eimi July 16, 2011 at 9:58 am

I adore Dave Ramsey, and followed his advice and got out of debt. I am a little sad to hear this news. I still will stand by his words, but in my opinion, Peer to Peer lending is a great way to re-establish your faith in borrowing. Banks have burnt me out, and I hardly trust them to put my paycheck in their business. We have a great APR with Lending Tree and convenient low payments to make. I am confident that when we pay off or first business loan in the next year and a half, we will be getting another loan to better our home business and even help us get our down payment for a home!

Investor Junkie July 16, 2011 at 11:33 am

@S. Mart Erthanu Dave like Suze has made most of his money from his books, seminars and shows, not from investing. Suze herself has most of her investments in US bonds (not stock).

His recommendation to use investment professionals (in which he also gets a referral fee) is at best OK advice. Investing in no load index funds is much better and cheaper. Investing is NOT rocket science and with limited expertise can have a well balanced portfolio.

While I have no issue of someone making money in educating someone about investing, there are MUCH better “gurus” to take your investment advice from. IMHO I would put Dave close to the bottom of the investment advice list. Jack Bogle is a much better person to take investment advice from. Even then none are perfect because they cannot speak for your personal situation and goals.

In an entirely different aspect of Dave is his advice to be completely debt free. While I’m NOT suggesting buying boat loads of stuff on credit, there can be some advantage of having low rate fixed debt (ie home mortgage) if we get a period like we saw in the 70′s. Instead his mantra is all debt is bad.

Peter Renton July 18, 2011 at 12:16 pm

@Eimi, I know Dave Ramsey hates debt but it is still not clear (at least to me) what his answer to this question would be: You have revolving credit card debt at 24%, but can get a p2p loan from Lending Club or Prosper at 12%. This will likely help you become debt free more quickly but should you do it? You see, you are not really adding more debt – you are just swapping 24% debt for 12% debt. I find it hard to believe that Dave Ramsey or anyone else would find that to be to a bad move financially. Best of luck on your home business.

@IJ, I am a big fan of the low cost no-load index funds at Vanguard and Fidelity. I agree that they are probably an appropriate investment for 95% of the population. I think the debt free mantra is good for many people who find themselves easily slipping into revolving credit card debt. But for those people who have that kind of debt under control, I think working hard to use all your extra cash to pay off a 4.5% mortgage doesn’t seem that prudent to me. As you say, some low interest fixed rate debt is “good” debt and shouldn’t stop people from starting a regular investment program.

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