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4 things to know about peer lending

Tired of earning next to nothing on your savings? Meet someone making 13% by simply doing what the bank does.

By Stacy Johnson Mar 15, 2012 10:11AM

This post comes from Brandon Ballenger at partner site Money Talks News.


Money Talks News on MSN MoneyIf you open a Bank of America savings account today and deposit $5,000, how much interest will you earn in a year?
  1. About $10.
  2. About $5.
  3. About $2.50.

If you guessed No. 3, you're right. B of A is offering an interest rate of just 0.05%. According to MoneyRates.com's quarterly survey, the national average for savings is 0.217%, and the best you can do is just 1% -- not nearly enough to keep up with inflation.


Possible solution? Cut out the middleman and do what the bank does: Lend your money directly to borrowers.  In the video below, Stacy Johnson talks with someone who's been earning more than 13% for years with peer lending. Check it out, then read on for more.

With peer lending, you join a site like Lending Club or Prosper, then start making loans and collecting interest. They find the borrowers, prescreen them for risk and do the paperwork. You decide your loan criteria, whom to lend to and how much to lend.

 

The lender Stacy interviewed was earning a 13.26% return on his investment, and he's lost no money to default since he started peer lending in 2009. But that doesn't mean losses can't occur, and unlike the major national banks, you're not too big to fail. So before you commit any money, here are four things you need to know:

 

Nothing is insured or guaranteed. Unlike the money in your savings account, these investments are not backed by the government -- or anyone else. Theoretically, you could lose it all. Even if a delinquent borrower eventually pays up through a collections process, don't expect to get the full amount you're owed.

 

From Lending Club's prospectus (.pdf file):

If collection action must be taken in respect of a member loan, we or the collection agency may charge a collection fee of between 30% and 35% of any amounts that are obtained. These fees will correspondingly reduce the amounts of any payments you receive.

The fees listed in Prosper's prospectus (.pdf file) are lower: 17% to 30%.

 

Default rates. Fortunately, borrowers don't default all that often, because peer lending companies like Prosper and Lending Club screen applicants for their creditworthiness. Prosper requires a credit score of 640 (calculated through Experian) and may allow loan requests of up to $25,000 based on the number. Lending Club only accepts applicants with "good" or "excellent" credit, and the "good" range starts at a FICO score of 660. Lending Club says it approves fewer than 10% of loan applications.

 

Flexible risk and reward. Loan requests are graded based on credit risk and have corresponding interest rates. At Lending Club, the average borrower rate for "A-Grade" loans is 7.39%, while riskier "G-Grade" loans can return 23.48%.

 

Prosper lists its ratings from "AA" through "HR" and provides an average loss rate for each rating based on historical data. As Stacy mentioned in the video, as a lender you can reduce your risk by spreading your money across several loans at the risk levels you're comfortable with and, of course, by paying attention to the applicants. The lender Stacy interviewed lends only $25 to any given borrower.

 

Eligibility. Currently, Lending Club and Prosper accept investors from 27 states, and you generally have to make at least $70,000 a year plus meet other state-specific requirements. You can see the list and other requirements online.

 

Bottom line? Peer lending can easily outperform savings accounts, and maybe even stocks. But as with any alternative investment, you need to learn before you lend. This investment model has been around for only a few years, as both companies' prospectuses warn in their "Risks" sections.


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