Saturday, September 30, 2006

Borrowers and Savers: Get Great Interest Rates

It amazes me how the internet enables new business models where individuals have access to a much larger interested population. eBay is the best known example of this concept. I can buy or sell an item in either a yard sale (low population access), in the classifieds (medium population access) or in eBay (maximum population access). has now created an on-line market place for borrowers to get lower interest rates and savers to get higher interest rates. Prosper gives maximum population access for the activity of people-to-people lending.

The process is simple. People who need money request a loan. People who lend money make bids to loan them money. Prosper puts in place the mechanisms to enable the process and minimize defaults. For this, Prosper earns a small fee, about 1.5%, for their service.

To minimize defaults, Prosper uses “groups” to verify borrowers are real people and to aggregate people of similar risk. Groups have will get lower or higher interest rates based on their reputation and borrowing history. Groups also provide social pressure since member’s repayment (or non-repayment) of loans will affect future interest rates for group members.

Interest rates range from 7% to 23%. This is often lower than alternative debt (e.g. credit cards) borrowers can get and higher than interest rates (e.g. CDs) savers can get. Bid amounts for loans are typically $50 - $100, with some bids as high $1000.

To be clear, there are risks for lenders. These are unsecured loans. If a borrower defaults, then the lender will lose the balance of the unpaid loan. The risk can be reduced for the lender by loaning many small amounts to different borrowers. This risk reduction strategy can work well if the relative default rate is low at an interest rate level, which is why Prosper appears to be attractive to individual small lenders.

Based on what I’ve read from their website, I am considering signing up with Prosper to bid on some loans. The possibility of 7-23% returns on a small part of my savings is very interesting.

Disclosure: I have no financial relationship with at this time. In the future, I may register to participate as a lender in the bidding process.

This is not financial, investment or saving advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

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