Running your own credit card company
Here is how I ‘run my own *credit card company*’ and charge people for 11.5% on personal loans.
Good track record: Someone mentioned about Prosper.com to me last year. It is startup creating people-to-people lending marketplace. Chris Larsen is the co-founder and CEO of the company. Prior to Prosper.com, he founded E-Loan and served as chairman and CEO there. E-loan closed $27 billion in consumer loan and went IPO in 1999.
Revolutionary concept: Prosper.com is probably the first company embraces the online P2P lending concept. Basically it does match making between small lenders and borrowers. For example, borrower Joe wants to borrow money to buy a computer. He either needs to use a credit card or personal loan . Interest rate for credit card is usually high (even for people with good credit score). In case Joe tries to take a personal loan through a bank, he probably won’t be able to do it because bank usually requires collaterals.
Win-Win: Prosper.com offers the 3rd option to Joe. He could get a loan (without collaterals) through a group of small private lenders (could be you and me). Each of the potential lenders bid for the loan. Jack may offer Joe a $100 loan for the rate of 9% , Jane offers $200 for the rate of 10% and so on. The lenders who offer the lowest rate win. It is a good deal for Joe because he usually gets much better rate than credit card or personal loan. It is also good for private lenders because the rate is usually higher than CDs, money market or saving accounts.
Trust system: Initially, I thought that it is risky because how do I make sure stranger Joe pays the money back. The solution from Prosper is simple and elegant. It shows the credit score and credit history of the borrowers. People know about that if Joe has defaulted any loan before or is behind on payment. They also work with collection agents to make sure loan is promptly repaid. If he doesn’t pay, his credit score will be hurt and makes it more difficult for him to obtain loans in the future. It is pretty effective.
Diversify: In addition, the system enables lender making micro-loans (as little as $50 per loan). If I have $5000 to lend to people, I could lend it to 100 people ($50 each). If one of them defaulted the loan, my overall return is reduced by 1% only. I think it is safer than lending the whole $5000 to my brother.
My result: I have been using Prosper for almost a year and nobody defaulted on me. So far, the ROI is about 11.5%, which is pretty good. I am lending to about 80 people. 60% of them have AA credit rating, 20% with A rating, 10% B rating and 10% C rating. On average, I charge 8-9% interest rate for AA borrowers and about 17% for C borrowers.
Finding the right borrowers:
- Don’t be greedy: although I could charge 25% or even higher interest rate by lending to people with credit rating D or below. However, I think that it is pretty risky because those are people who are likely to have financial difficulties.
- history will repeat itself: if someone defaulted a loan before, he/she is likely to default again. Avoid them.
- Low DTI ratio: DTI stands for “debt to income ratio”. The lower the DTI ratio, the more spare money the borrower has and more likely they will repay you.
- Autopilot: I know that it could be additive to monitor the bids closely. However, I prefer to do it in a scientific way. Prosper has a feature called “standing order”. You could specify the criteria which borrowers should match (e.g. high credit rating, low DTI ratio, etc) and Prospers places the bid for you should there be a ‘qualified’ borrower. It is a pretty good feature and I could sit back, relax and my money grows
Note: Copyrighted 2008 MyBuckBlog.com. All rights reserved. Permission granted to reprint this article on your website without alteration if you include this copyright statement and leave the hyperlinks live and in place.