Mighty Bargain Hunter

Taking the ROI bull by the horns

October 5th, 2006 | by mbhunter |

Found out through the blog grapevine that Dual Income No Kids is putting $70k on the line for person-to-person lending at Prosper.com, mainly with the intent to loan to high-risk, high-return borrowers.

I’m a lender at Prosper.com and I’ve currently transferred a mere 0.1% of that amount. It won’t bankrupt me even if all of the borrowers skip town. But $70k would buy a house in some areas. It would buy three houses in others!

Personally, it’s not a risk I would take because I’m relatively risk-averse. Just check out my posts on Missed Fortune 101 and you’ll get as much of a flavor as you ever wanted! (Maybe if I had $50 million — then I could afford to throw $70k at it!) But they’re not me, and the sheer volume of capital could work to their advantage, and I certainly hope it does. It’s a bold move and I hope it works out for them.  (UPDATE:  They’ve decided against going this route.  Didn’t read far enough in the blog!)
So, here are some things I’d consider if I were going to do this:

• I’d transfer it in a little at a time. Maybe a couple thousand at a time. The main reason is that since it’s a huge amount of money, it will take a while to commit it all to loans if you want to diversify properly. If the money is sitting in your Prosper account, it’s not earning interest. If you put $70k in an online savings account like ING for example, it will earn over $250 per month.
• I wouldn’t rush to commit the money the first month. $70,000 rushing into the system in one week is a disruptive move because the market at Prosper isn’t that big yet. You’ll be able to commit it but odds are you’ll get a lot lower return on your money than if you trickle it in. (Having said that, as more lenders come on the scene, the returns will go lower too, so this advice may backfire.)
• I’d reinvest at least part of it. An 18% return on an amortized loan repayment over three years only gives about half that if it’s not reinvested. Most of the interest is paid by the borrower at the start of the loan, then goes down to almost nothing near the end. Reinvesting will boost the rate of return closer to the 18%.
• I’d be picky! Regarding high-risk loans, there are better risks than others. Why does the person have a bad credit rating? Was it within his/her control? Low debt-to-income could be a plus, as could a reasonable explanation for a bad credit rating. Putting in an automatic id for any and all HR or NR loans just because you can is a bad idea. I believe it’s possible to do better than the posted default rates with your portfolio with some thought and research.
• I might be diversifying too much. Having just talked about the need to be picky, the more loans you have in such a small market, the more likely you are to catch every last deadbeat borrower and the more likely you’ll live up to the default rates quoted by Prosper.
• I’d start with some low-risk loans. $2,000 loaned to AA-rated borrowers at 8% will almost certainly return enough to fund one loan per month (the payment is $62.60, and the minimum reinvestment is $50). This is the kindling that will let your portfolio support itself; you should be able to reinvest regularly without any new money at this point.

Just some food for thought. Assuming that If James and Miel will continue had continued this path, does anyone else have any other suggestions?