Prosper Lending Return on Investment Analysis

IndexFundFan alerted me to an excellent review for person-to-person lending on Prosper.com by Jonathan at My Money Blog: part 1, part 2. I wrote about Prosper in a previous post Prosper.com Or Junk Bond Fund?, in which I said if people want to take credit risks, there are other places to take them, such as a junk bond fund, or just becoming a part owner of a bank or credit card company (buy their stock).

Jonathan looked at the numbers and concluded that the returns on investment for Prosper loans ranged from 8% to 10% on better credits and -30% to -10% on bad credits. While the numbers on better credits are higher than what a bank saving account pays, you can’t really compare lending on Prosper to a bank savings account. Prosper is asking lenders to become amateur loan officers. I don’t see how amateurs can do better in pricing risks than financial institutions who perform credit evaluations day in and day out. Also, if you think you do a better job as an amateur loan officer, you ought to pay yourself a reasonable salary for doing that loan evaluation job. After subtracting that salary from your return, you may find that your return is far less. In contrast, putting money in a bank savings account is much more scalable and requires little time and effort.

There are news these days about subprime mortgage lenders being burned by defaults. All of them are tightening their loan standards. Some of them are in danger of bankruptcy. See How To Do A Liquidation Analysis of New Century Financial at Watch Your Wallet. Well, despite being subprime, at least those mortgage loans are secured by real estate. Prosper loans are all unsecured. Defaulted loans are sold off at 10 cents on the dollar. Ouch!