Prosper, part 1

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Here is Part 1 of a piece about my next attempt to make money. This is only part one (in fact of how many parts, I don't know) because I have yet to make a dime from my idea. But I think it has the potential to make a decent little bit of money.

So here's the scoop: A while ago, I was reading yahoo finance... google finance... maybe even the New York Times, and I came accross an article about a company--an online company to be more specific--that allowed subscribers to a website to make loans to each other at varying interest rates. The name of the site is www.Prosper.com.

I suppose this is the point where I have to admit something to you. I'm not entirely broke. I have a little money socked away in one of those high yield internet savings accounts. In fact, I plan to talk about that in a later post. But anyway, here I am with a couple of g's socked away for no particular purpose (I don't have any desire whatsoever to spend the money given that it took me so long to amass), and so recently I thought to myself: "Why don't I test this prosper site out?"

So now I have. I had to set up an account (it wasn't particularly difficult. I had to verify a bank account, give my social security number, and transfer some money in). Then I made a few test loans. Let me tell you what, to this point, I have discovered.

First things first. The groundrules and what I believe is the theory behind making money on an online lending site like www.Prosper.com. Because I don't think it's entirely self-apparent. If you are a lender, Prosper provides you a rather substantial list of users with different credit scores who are requesting loans. They are rated AA-High Risk. Supposedly default rates for the AA and A lenders is below 1%. You are also provided with information about deliquent accounts, credit inquiries, revolving credit line, and credit line usage. After you look at all this information, you are allowed to bid a minimum of 50 dollars on each loan. The idea is that lots of people bid little amounts of money per loan and so the risk is spread around. More on that later. The loans are for a term of 3 years.

So how can we make this work in our advantage? Here's the theory. Let's start with a test case of lending 1500 dollars for 3 years at an interest rate of 13% on Prosper. I choose this sum because it is the lowest realistic dollar amount that produces a self-sustaining investment. Every month, you will receive about 50 dollars, thus the minimum amount required to invest in a loan. This is very important. In order to really make money, a reinvestment of the 50 dollars each month is precisely necessary.

Let's say we don't reinvest. What happens then? Well. Each month we get 50 dollars. Let's say we spend it... or put it in our checking account. At the end of the 3 year period, we will have earned 319 dollars in interest. Not bad... That comes out to be about 21% of the principal. But. And here's the kicker, if we were to put the same 1500 dollars in a simple savings account earning 5 percent interest, we would end up with nearly 250 dollars in interest over the same period of time. And with a savings account we can take the money out at any point. In my mind at least, those extra 70 dollars aren't particularly worth the cost of not being able to touch the money in total for 3 years.

The situation changes a lot if instead of keeping that 50 dollars, it is reinvested. I recommend back into Prosper. But conceivably, the idea also works if you put it into one of the 5% high yield savings accounts as well--you just end up earning less money. Of course, by the way, you must realize that when we do what I am suggesting suddenly we are talking about making a longer term investment. Four or five years at least.

So what happens if the money is reinvested at 13% back into prosper? I have done the calculations. I won't bore you with all the numbers. But basically, the first year, you stand to make about 10% on your investment. And each subsequent year an increase of a couple of percentage points. In total after 3 years, you end up with about twice the amount of interest you otherwise would have if you had just taken the money out. About 630 dollars, if my calculations are correct. And at that point, you stand to make a little bit more given that you will have almost three years of loans that you have made that have yet to reach maturity. In total, you make 2 times as much as taking the money out of prosper and 3 times as much as you could make by just leaving the money in a savings account to compound.

That's the idea behind making money at a place like Prosper. I'm not quite sure if it works yet. As I said before, I have made some initial loans of 50 dollars to figure out exactly how it works and how reliable it is before I invest anything more. But so far, I am pretty impressed. I bid on two loans (100 dollars), one at 13 percent, the other at 14.5 percent. Each of the lenders was advertised as having an A or AA credit history. It also seems that Prosper takes every precaution to avoid fraudulent loans. After enough people have bid 50 or however many dollars to meet the loan, Prosper reviews the loan and performs a kind of background check on the borrower. This process can take up to a week. In case people do default, Prosper uses real collection agencies in case people default.

Once I have more information, I will pass it on to you.