Learn To Lend

What you should know if you want to be a peer-to-peer lender

Lending money on sites like Prosper & Lending Club can be a great way to diversify your investments if you take the right approach managing your downside risk.

Who doesn’t want to maximize returns and reduce risk, but it’s easier said than done right?  A recent article from MarketWatch offers some advice to lenders on how to go about lending strategically. Mark Meyer, director of the Filene Research Institute, starts it off by pointing out the relationship between the projected return on the loan and the potential for default.

“Assume that the higher the return is going to be, the higher the risk is going to be if you’re a lender.”

Typically, borrowers with stronger credit histories and low amounts of debt will pay lower interest on the money they borrow.  If you as a lender are determined to get the maximum interest rate, you’ll likely have to lend to people who have been or are currently in a worse financial condition and are more likely to not pay back the money they borrow.

The MarketWatch article gives the following tips on maximizing your return and reducing your risk on sites like Lending Club & Prosper:

Know the Lending Standards

• Lending Club borrowers are required to have a FICO score of at least 640 to get a loan
• Prosper has no minimum FICO score, if enough people are willing to bid on a high risk borrower the loan will get funded
• Zopa utilizes credit unions & certificates of deposit to reduce risk but the result is lower returns

Use Logic Over Emotion

• Borrowers on peer to peer lending sites offer a profile of their financial situation. Your risk goes up considerably if you base your decisions off of the emotional appeal of their loan request instead of their financial ratios

Diversify Risk

• Don’t put all your lending money into one loan, instead of lending $1,000 to one person, fund 20 loans each with $50
• If you do lend to a high risk borrower, also fund a low risk loan to even  out your downside

Take Babysteps

• Avoid investing large amounts right off the bat.  Make a few small loans to get comfortable with the process. Once you’ve evaluated what went right or wrong with the first few, then you can move on to larger size and quantities of loans

Source: MarketWatch.com: Looking for lenders: Peer-to-peer lending sites can offer attractive returns, but be careful