Your guide to peer to peer lending

Top 10 Reasons to Invest in P2P Lending in 2011

by Peter Renton on January 3, 2011

Peer to peer (p2p) lending had a great year in 2010. Well over $150 million in loans were originated by the top two p2p lenders in this country, Lending Club and Prosper, the most ever. Tens of thousands of investors enjoyed returns in the double digits. Now, 2011 is shaping up to be even bigger. Here are the top 10 reasons you should jump on the bandwagon and invest in p2p lending in 2011.

1. CD’s are still paying less than 3%

According to bankrate.com, the maximum return you can get on a five year CD right now is 2.61% (for three year CD’s the maximum is 2%). Sure, your deposit is insured by the FDIC but there is a good likelihood that you will lose money to inflation before the five years is up. With interest rates at record low levels the best you can do with CD’s is simply protect your capital, you really can’t grow your nest egg.

2. The stock market is fickle

The stock market had a decent 2010, but with the memories of a disastrous 2008 still fresh on everyone’s mind, we all know the stock market can be fickle. Not even Warren Buffet knows what the market is going to do in the near future. There are some commentators saying that stock market returns over the next ten years will be sub-par.

3. You choose your level of risk

With p2p lending you can choose beforehand the level of risk you want to take. Whether you want to invest in people who have great credit and a large income for a modest return, or take on a higher risk for a potential higher return, you get to decide.

4. Investing in real people

One of the most gratifying things about p2p lending is that you can know exactly where your money is being invested. You are investing in your fellow Americans, most of whom are genuinely trying to get ahead in life. You can read their story and invest in real people. Help people consolidate their debts, start a business, or pay for a wedding. You get to choose who gets your money.

5. Avoid dealing with banks or Wall Street

It is generally accepted now that mismanagement at the big banks and the financial institutions on Wall Street was one of the main causes of the financial crisis that has affected us all. They made some incredibly poor decisions and showed a level of greed that was unprecedented. But the big bonuses have largely remained intact. With peer to peer lending you can earn a great return on your money and completely bypass these institutions.

6. You are contributing to the economic recovery

By investing in individuals and small businesses, many of whom have been rejected by the banks, you are helping to stimulate the economy. You are creating liquidity in the financial system and providing funding to people who might otherwise not have been able to obtain a loan.

7. Start with as little as $25

You don’t need to be a millionaire to start investing in p2p lending. If you forgo a week of Starbucks you can get started with the money you saved. You can then continue to invest in these small increments. Many mutual funds and banks require you to start investing with hundreds or even thousands of dollars.

8. Add diversification to your portfolio

Most financial planners preach the gospel of diversification. The belief is that by holding a broad range of asset classes you can minimize your downside risk. In theory different asset clases should not move up or down at the same time. This is mostly true except in rare cases such as the crisis in 2008, when just about every asset class lost value. It is better to diversify into completely unrelated asset classes and that is what p2p lending provides. It does not move up or down in correlation to any other investment class so it provides true diversification to an investment portfolio.

9. P2P lending is completely transparent

Do you have any idea where your money goes when you put it in a CD, savings account or mutual fund? Of course not. But with p2p lending you can see exactly where your money has been invested. Not only that, you can also see how all or any of the loans are doing whether you invested in them or not. Because they have to register with the SEC you can also see the financial health of Lending Club or Prosper by reading their SEC filings. Finally, if you have the time and energy you can download the entire loan portfolios and run your own analysis.

10. Earn 10% (or more) on your money

This is the bottom line for most p2p investors. The rate of return is better than you can get almost anywhere else. The average stated returns at Lending Club is 9.7% and at Prosper it is 10.4% (since they reopened in July 2009). There are people getting returns north of 15% and some people do even better than that. But even if you do about average for a p2p investor you are getting a great return that can allow your money to really grow.

I truly believe that p2p lending should be part of every investors portfolio.  These are my top 10 reasons you should invest. I would love to hear what others think – please let me know why you invest in the comments.

{ 18 comments… read them below or add one }

Aaron January 3, 2011 at 2:23 pm

While I completely agree with 3-5 and 7-9, I would like to point out some flaws in the rest.

1. Bank CDs at less than 3%. I don’t really understand why this one made the list. Maybe because I don’t really see it as an investment vehicle. CDs are used more as SAVINGS rather than actual investment. Plus, the author is comparing two completely levels of risk. Bank CDs are arguably the 2nd safest place to put your money other than Treasuries. There really is no way for you to lose money unless you have more put in this vehicle than the FDIC will cover (I believe now it is $400k). The rate or return, in my opinion reflects the level of risk involved. P2P lending is still in it’s infantcy and a high risk proposition. People put their money in CDs to prevent inflation from eating up thier savings.

2. The stock market is fickle. Yes. It is, but to be honest, so is p2p lending (hypothetically). A stock market tank like what we saw in 2007 and 2008 brings with it (and is reflective of) a falling economy. Unemployment rises dramatically and people are unable to pay off some of their debts. A smart consumer will pick and choose what debts to pay and the “unsecured” debt will likely be the first candidates to skip payments on. I believe we saw this on Proseper prior to the quiet period. (I wasn’t part of lending club yet so I don’t know about them.) Yes their credit standards were a bit more lax then, but it would be irresponsible of us to discount the economy as a default factor for the horrible returns (averaged at -5% during that time period.) After the quiet period the economy has been steadily improving and the rates are getting a bit better. Either way, stocks should always still be a part of your investment portfolio and I agree that p2p would be a nice addition to it.

6. You are stimulation the economic recovery. I say yes and no. Yes, you are giving YOUR money away for others to SPEND which is initially a boost, but remember that these people have to pay you back WITH INTEREST. You are basically making people spend money today that they have to earn and pay you back again later. Those payments back to you take money out of the economy that would otherwise be spent. It’s get worse when you factor in interest. If you put your money in a bank, it would do basically the same thing. The only difference is that you are loaning the bank money to loan to other people. I know this sounds complicated, but if you really think about it, banks would just do the same thing with our money that we are doing with p2p. You get a much lower return with banks because you are letting this third party institution take all the risk. In p2p lending, we take on the risk of loss, so we get the higher return.

Finally #10. Earn more than 10% on our money. Most of these numbers from lending club and prosper are hypothetical based on a formula they have created on different past defaults at different credit ratings. They also include new issues in their equation. I am more inclined to wait until after 3 years (the typical loan term) in my investing experience before I believe any of the numbers I see on this subject. I have been investing in p2p for almost a 8 months with interest payments (after defaults) in excess of 3.8%. That means I’m on pace to make 5.7% after 1 year investing. Not too shabby, but not extraordinary either. I am eager to see what happens .

peter January 3, 2011 at 3:47 pm

Aaron, Thanks for your detailed comments. You raise some interesting points. Here are some additional thoughts:

1. I included bank CD’s because they are so very popular right now. People have withdrawn their money from the stock market and bond market and put them in bank CD’s. P2P lending competes against all other investment vehicles including CD’s which is why I included them here.

2. The past decade has seen a relatively flat stock market and the coming decade may well provide more of the same. With my p2p lending investments I will be very surprised if I haven’t doubled my money by the end of the decade. While I have a good chunk of money in the stock market I expect it will lag my p2p investments over the next few years.

6. I am not an economist so I can’t really argue your point here. But surely if someone is paying 25% interest to a credit card company and then consolidates that debt down to a 15% interest rate isn’t that going to have a stimulative effect? It puts more money in that person’s pocket every month.

10. It is true that the track record is short in p2p lending. Lending Club’s new lending policy went into effect in October 2008 and Prosper 2.0 started in July 2009, so we haven’t run the full 3 years on the loans with either company. I think we will get a more accurate picture as time goes on, but I stand by my 10%. My real world returns come close to that. I will be doing a blog post about ROI and actual vs claimed returns later in the week.

Finally, you never did mention why you decided to invest in p2p lending. I would be interested to find out. Thanks again.

Aaron January 3, 2011 at 5:59 pm

Lol. Sorry about that. I wasn’t very clear in my reponse on why I went into p2p lending. As I stated before, I agree to points 3-5 and 7-9. Those are reasons why I hopped aboard the p2p lending process. If I were to put my finger on the MAIN reasons it would be 4 and 5. I don’t particularly like the idea of banks (mainly their profit structure.) I do, however, usually get a warm and fuzzy feeling when I lend money to people or causes I believe need help. As long as my returns are as good as or better than what I would normally invest in, I will call it a successful investing experience.

Back to our comments, and thank you for responding.
1. True, but I still believe the CD rate is largely irrelevent because you are dealing with completely different risk. People ran to CDs and Treasuries because all other investment vehicles seemed too risky. People will pop their heads out of the sand more when the coast seems clear. As long as the FDIC covers account holders, CDs will always have the lowest rates fixed rates regardless of the economic situation.

2. I take your point, and I’m hoping to achieve the same via my lending account. I just caution those that would assume that social lending is free from the same market forces that the stock or bonds are affected by.

6. I agree with the debt consolidation aspect, but it still doesn’t apply with loans made for any other reason. Most of the loans taken out on p2p are “New Debt”.

10. Sounds Great :)

ts January 4, 2011 at 8:57 am

I think the returns on loans held to maturity are even negative for some credit brackets, with 10-40% default rates depending on the credit rating on Lending Club for pools of loans made in 2007 if you punch in those custom dates on their website (to get loans that are now mature). 9.6% returns is a joke that includes loans that haven’t had a chance to default yet:)

Peter Renton January 4, 2011 at 11:10 am

Aaron, Thanks for sharing your reasons for investing in p2p lending. One last point I would make. You say that most p2p loans are for new debt but according to LC’s stats page 63.34% of LC loans are for credit card payoff and on Prosper they are also the largest category by far (according to lendstats.com).

ts, You are quite right in pointing out that the returns from 2007 are terrible and nothing like the 9.6% claimed now. However, LC tightened their lending policy in Oct 2008 and you will notice returns are up since then. Now, we haven’t run the full three years on these loans yet, but I think you will find defaults are way down and returns are up since then. So, are you an p2p investor? If so, why did you invest?

ts January 4, 2011 at 5:44 pm

Peter – you say they tightened credit standards which yields a better return but even after they tightened lending standards, picking dates from say Oct 2008 – Jan 2009 to get loans that are still fairly old, NONE of the returns are 10%, F & G grades are negative 25-35%, and they aren’t even mature yet… am I wrong? Please shed some light on any data that suggests if I invest $1k today I’ll have annualized +9% return on that $1K 3 years from now. Thanks!

Peter Renton January 4, 2011 at 6:07 pm

ts, I would encourage you to check out lendstats.com and also @Matt_SF of Steadfastfinances.com. Lendstats.com will give you a number of loan criteria that shows loans that have performed well even since 2007 (check out general filter 1 for LC – it returned 8.64% for loans issued in 2007). If you want to use Matt’s cherry picking criteria at Steadfastfinances.com I will be shocked if you do less than 10% over the next 3 years, he is at 15.6% after 18 months. There are no guarantees but I firmly believe with some research and thought you can get great returns on either LC or Prosper.

Dan B January 4, 2011 at 8:48 pm

Peter, I’m sorry but you’re wrong on so many levels that I’m not even sure where to start. I will not comment on Prosper since I’m not an investor there but suffice it to say that Prosper has done horrendously for its investors. In no specific order I will touch on a few that i can’t let slide………….
1. Yes, 63% of borrowers say that their LC loans are for credit consolidation, but there is absolutely no way of confirming this. Please don’t state that number as if it was a “fact”. It’s not. It’s just what they say they’re going to do in order to get a loan.

2. You are grossly understating the risk factor. With ever increasing loan volumes it is easy to paint a rosy picture because the loan age is so young. The FACT is that the “median” age of LC loans is 9 1/2 months old. One needs to only look at the statistics page figures to see this. Now considering that it takes a minimum of 4 months for a loan to default (ie 120+ days late) one can easily see that the average loan has only had 5+ months to potentially become a problem. That’s 5+ months out of a 36 or 60 month term.

3. As for Matt at Steadfastfinances, I’d suggest you ask him what the median age of his portfolio is. It isn’t more than 6 months. Check back with him 12 payments from now & see where his 15% number is at. Then remember that at that point (12 months from today) his median loan would still have another 40+ payments to go. Matt, invests mostly in 60 month loans!

4. The LC 9.68% average return is an illusion. as I’ve stated a few times, it doesn’t take into account funding time, issuing time & assumes a theoretical immediate reinvestment. For proof that the 9.68% average in bs, one need only look at the subgroups of investors with 0-$5k, 5k-10k, 10k-20k, 20k-30k & so on upwards. None of these groupings do an average of 9.68% or better…………………NONE. Don’t believe me? Look at your own bracket, then ask around. So…………..for all the above reasons & others that I don’t even want to go into, can we stop pretending that 9.68% is a real number? Please?

Dan B January 5, 2011 at 1:02 am

And one more thing that’s slightly off topic…………….You know what I see as the real threat to this whole p2p thing? It’s not you or I or some guy who splashes a couple of thousanf on 100 notes………..& then later comes here pissed off & rants about not getting 9.6% or whatever.
No, what I see happening is some other guy later this year or next year who hears & believes all the p2p hype & how these are “prime notes” (LCs words, not mine), then reads & believes that this is some sort of a “safe” or low risk 9.68% alternative to CDs. This guy then drops $3 million in $3000 increments into 1000 notes in short order using the automated system. He them goes to the Riviera on vacation & forgets about his small investment. A year or 2 down the road he comes back to find that his widely diversified 1000 note portfolio has defaults up the yin yang & that his NAR is now at 3.5%. Instead of coming to /, this pissed off guy who has money, calls his lawyer & they call the regulatory agencies………….& the caca will then hit the fan. This firestorm will cause the p2p companies to lower their stated return to say a 5-6% return with an asterisk next to it warning everyone of the “high risk” nature of the p2p investment & the potential loss of principal.
Meanwhile, remember that we’re looking at 1-2 years in the future & CD interest rates which have nowhere to go but up, would possibly/likely gone up by then. The new reality in late 2012 or 2013 could easily be a 3 yr FDIC CD paying say 4-5%. At that point, who is going to invest new money into unsecured “high risk” p2p loans offering 5-6% with an asterisk warning of possible principal loss???

Peter Renton January 5, 2011 at 10:53 am

Dan, Thanks for your comments. Here are my thoughts:

1. Yes, it is true that we don’t truly know what people are doing with their money when they borrow on p2p lending, but that also applies to many things on their loan application. But I still maintain that the largest category of borrowers on p2p lending sites is for debt consolidation. Whether it is 63% or 43% no one really knows, but it is a large percentage in my opinion.

2. I have never maintained that there is no risk in p2p lending. I think the rewards are worth the risk and there is no way to earn 10% on your money with no risk. You are quite right in pointing out that most loans are still very recent and have not had much chance to default, but let’s look at some numbers. If you take all 2009 loans (median age would be approximately 18 months old). So you have received principal and interest payments for roughly half the loan term. The returns are around 8-9%. Take out Lending Club’s overestimated NAR (around 1% in my experience) and you are looking at 7-8% returns. Not quite the 9.68% but not that far off. Will there be more defaults on 2009 loans? Absolutely, but these defaults will not eat into returns as much because you have already received more than half your money back on these loans.

3. I agree that Matt with Steadfast Finances also has a young median age of his portfolio, but I would be curious to know what you think his returns will end up at? Do you think 15.6% returns will eventually become 5%? I think that is highly unlikely. My best guess that his returns will stabilize in the 11-13% range. Only time will tell.

4. Yes, the 9.68% returns is very likely an overestimate. But I really don’t believe that the average return is going to plummet to 5% or less.

Dan, the problem we have is that we are arguing about the future which is unknowable to either of us. You think returns will be low, I tend to think they will be higher. One of us may be right or it might end somewhere in the middle.

My question to you is this. I know you are a Lending Club investor from your comments on Steadfast Finances. You seem somewhat negative in most of your comments, so why are you an investor in p2p lending?

Jack January 5, 2011 at 11:29 am

I think this is a good summary of P2P Lending and the value of the business model. It is not perfect….but sure seems to beat other investment vehicles at this time. As noted in the comments, it is not without risk. However, I think the industry is getting wiser to that with tracking and reporting of historical performance. I also really like adding collateral to these loans like http://www.money360.com has done. They seems to provide same returns (8-12%), but with much less risk because the loans are secured by real estate. It looks like they do require a larger investment of $50K minimum, but what a great model for those of us sold on the future of P2P Lending.

Peter Renton January 5, 2011 at 2:34 pm

Jack, I fully expect collateralized loans like Money360 is going to happen soon. It has already started in Canada with car loans. You can now get financing on car loans through AutoTrader.ca and Communitylend.com there. Cars seems like a good fit to me because the amounts are typically less than $25K, particularly in the used space. It would be great to do for home loans although the p2p lending industry needs to be much more mainstream before I see much movement there for the average investor. Thanks for your comment.

Dan B January 5, 2011 at 5:51 pm

1. So “in your opinion” the largest category of LC loans is debt consolidation. There is no evidence whatsoever to back up this statement, is what you’re saying. As long as no one tries to suggest that it is factual………..I have no problem. I, on the other hand agree with Aaron & believe that the largest category is in reality…………”new debt”.
2. Again I think you’re overstating the potential returns. Here’s a fact taken from LC “account summary” page & I quote…….

“77.54% of investors have earned between 6-18% net annualized returns since inception”.
So let’s flip this around & it will now say that 22.5% of investors have earned under 6% NAR since inception. In other words………..1 of every 4.5 investors have made less than 6% returns. Of course in the real world that number is now a under 5% return. I believe that LC has around 47,000 lenders total. So, about 10, 475 are currently earning under 6% NAR & 5% real world.
So I don’t think that my estimates of how the “average” investor will fare is too pessimistic. The reality is that almost one quarter of investors are already doing numbers below 6%. Couple that with the age of the average LC loan, the declining interest rates offered for A & B 36 month loans & I guarantee you that that “under 6% NAR” number will increase substantially………….perhaps to as much as 50% of investors returning under 6% NAR over the course of the 3 or 5 year term.

Don’t underestimate how severe the defaults will get………..According to LC the 2nd year of a 36 month loan is where the vast majority of defaults occur………….& I think they’re absolutely correct. My NAR for my first year at LC hovered around 12.5-13%. In a period of 1 month shortly right around my 14th month (1 month ago) I saw my NAR drop to 9.5% as 4 “lates” turned into defaults. I made some labor intensive adjustments to my investing by getting rid of any notes that even smell like they might go into grace period & have been able to get back to 9.9% NAR as of today. If I hadn’t taken this aggressive approach I’d have been likely staring at another half dozen defaults by now. You think I’m exaggerating? Let me share this…………….Today is Jan 5th. So far this year I’ve sold 25 notes, all of them current when sold. 2 of them are now in “grace period” Last month I sold 114 current notes. At months end, 3 were in grace period & 1 was late 15+ days. So in the last 5 weeks during the first few months of my 2nd year at LC I’ve had 1 note go late & 5 notes go into grace period. Those numbers are higher than what I experienced in my first 12 months combined! Be prepared!

Peter Renton January 5, 2011 at 6:07 pm

It looks like we continue to disagree on many things here. I just have one comment. I must take you to task on your “guarantee” that the under 6% numbers will increase substantially. You obviously can make no such guarantee, but I get that you strongly believe this. I believe differently and here is why. In late 2008 Lending Club changed their underwriting standards substantially, so I would guess that a large number of the sub 6% group are the early investors. Just like with Prosper, the early investors did much worse than investors who came on board later.

Dan, you still haven’t answered my question. Why are you a Lending Club investor? From what you have been saying you seem very negative on both LC and p2p lending in general.

Dan B January 5, 2011 at 10:38 pm

Peter, you run /. I don’t think it would be going out on a limb to suggest that you’re somewhat predisposed to be positive on p2p. So I have no expectations that you’ll agree with my comments, predictions etc. However I’m not just walking in here & spewing a boat load of unsubstantiated claims. When at all possible I’ve used LC numbers to back up my claims.
Your question as to why I’m an LC investor even though I have reservations & criticisms precisely illustrates what is wrong with p2p & LC today. I have serious questions about the stock market too. Should that make it somehow unusual that I’m a stock market investor? Few investors in p2p seem remotely interested in anything resembling due diligence, few if any investors challenge what is said,. You & a lot of people are giving these companies too much of a free pass. Serious questions are rarely asked & when they are asked they’re either answered with wishful thinking, some canned response or not answered at all. And I don’t mean just here. It’s the same at LC. Have you ever attended one of their investors web discussions?? I’ve attended 3 & they’re like an infomercial. Ask a serious or pointed question & the answer is something obtuse or otherwise unsatisfying. And the worse part is that they consistently get away with these vague or lightweight answers.

I’m not a cheerleader, & I’m not a fan of p2p. I’m not interested in the social aspects & all that feel good crap. I’m not on some bs anti-bank crusade. I’m looking at it as strictly an investment, & as an intellectual exercise I’ve decided to test it out. That’s why I’m a LC investor. But I’m not putting new money in play & I’ve been reducing my exposure & will continue to do so by selling any & all notes at the ridiculous 2% net premiums that I get all day long. It’s great for me but the fact that I can sell notes heading down the crapper ………at a premium no less, is another example of the utter lack of sophistication & understanding that seems to permeate the p2p investor community. But hey I’m perfectly happy to sell a $1 to someone for $1.02 or higher all day all night long.

Peter Renton January 6, 2011 at 11:27 am

Thanks for your comment as always Dan. You are right I am very positive about p2p lending but I am also into the truth. That is why I have always welcomed your opinions because I don’t want this blog to be about “spewing a boatload of unsubstantiated claims” as you say. I happen to believe the future of p2p lending is rosier than you as I continue to put new money to work here. But I will continue to monitor both my investments and the results of all p2p lenders.

So, once again I thank you. I think it is useful for my readers to hear from different perspectives and you provide some excellent feedback and food for thought.

Dan B January 6, 2011 at 2:46 pm

Peter, since you’ve stated that you’re into the truth let me ask you this…………. what percentage of borrowers (do you believe) lie or provide inaccurate information on p2p loan applications?

“Approximately 60% of listed loan applications are selected for income or employment verification. For the three-months ended
June 30, 2010, approximately 61% of requested borrower members provided us with satisfactory responses to verify their
income or employment; approximately 13% of requested borrower members withdrew their applications for loans, and
approximately 26% of requested borrower members either failed to respond to our request in full or provided information that
failed to verify their stated information, and we therefore removed those borrower members’ loan posting.” (LC prospectus pg.15)

How confident are you now that 63% of borrowers will really use the money to pay down their credit?? Yeah, sure they will.

So let me see if I have this right…………….Investing in a p2p note is a “high risk” (LC words, not mine) unsecured, illiquid investment from a company with less than a 4 yr track record. A company that prides itself on transparency, yet doesn’t make it known that their official returns consistently overstate real world returns by 1-1.5%…………. Investments that are in actuality unsecured notes of the company itself…………..a company that’s never turned a profit & has not given any guidance as to if & when they will turn one in the future……….a company that that is entirely dependent on outside financing to fund their on going operations. And the return on & off the money that us lenders invest is dependent greatly on the integrity of individual borrowers…………39% of which apparently lie or make dubious claims on their loan applications!

Yeah, you know I must be crazy for not being more positive on the type of returns one can make as a p2p investor. No dangers here. :)

Peter Renton January 7, 2011 at 12:10 pm

Dan, The numbers you state on borrower responses are not a surprise to me. I remember when I scanned through the prospectus coming across that section. Does it impact my view of p2p lending as a good investment? No. There will always be people who try to game the system and I expect as Lending Club continues to improve they will try and intercept more of them before they can reach the lender.

Yes, LC has less than a 4 year track record, has never turned a profit and continues to make losses. If you look at their last 10-Q filing you can see at the current burn rate that they likely have 2-3 years of cash left before needing another capital infusion. I hope and expect that by then they will be cash flow positive and need no further major funding.

Dan, I am aware of most of the things you state here and yet I continue to believe in the positive future for Lending Club and p2p lending. It is clear you do not and that is fine. One of us will likely be right – whether it is you or I only time will tell. But I continue to welcome an active debate on the topic.

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