Peer to peer lending is an excellent way for those with spare savings to gain higher yields than traditional investments return, without exposing themselves to the stock market. Sites such as Prosper are extremely well set up for individual investors to spread their risks by loaning in small increments to peers who are currently credit constrained.
Evaluating the risks attached to individual borrowers is made easy as the system posts its own version of credit score analysis based on two factors. It considers the traditional Fico score of the borrower together with its own analytical credit score based on its own rating criteria. Borrowers are then given a score off AA down, with AA representing the least risk. The scores indicate “predicted estimated average annual loss rate”, with an AA score equating to 0 – 1.99% estimated loss. In comparison a C rated Prosper borrower has an estimated 6 – 8.99% loss rate. These scores are “based on historical performance of Prosper loans with similar characteristics.”
A lender thus has an immediate tool to determine if they prefer to lend to a low risk borrower which in turn yields a lower return than a higher risk borrower. In addition lenders have access to personal data provided by the borrower and accessible through their profile. Photographs of wholesome and smiling borrowers are posted together with their reasons for requesting a loan, and their personal commitment to repay. Lenders also have the facility to contact the borrower for additional information.
The savvy lender will go further in evaluating borrowers though and study data produced by peer to peer lending analysis, which goes much further in explaining and indicating predictive behaviour of borrowers. An excellent study conducted by the Bank of Canada using Calmeadow data reveals interesting information based on past delinquency rates, and lenders should consider this type of independent data in conjunction to information posted on actual peer to peer lending sites.
Data on Calmeadow delinquencies illustrates that larger loans, taken for longer periods and with higher monthly repayments, are more likely to suffer delinquencies than loans for smaller amounts over a shorter term. Individual borrowers who are more likely to default are single males with a low education and less business skills. This predictive analysis also incorporates a higher credit utilization figure and a poor credit history.
Delinquencies are also predicted to be higher for business start ups outside the home, an area which it is tough to obtain traditional bank financing in. Thus a D rated borrower with a reasonable income becomes high risk if the loan is needed to start a business as the income will disappear, whilst another D rated borrower whose household has a dual income and needs a loan to pay off a home improvement loan, but has a steady job, is a safer risk.
Naturally the best way to evaluate the system is to spread your risks between AA and D rated borrowers and thus form your own analysis. With increments of only $25 needed it is simple to determine through actual investment how high a risk a lower rated borrower is, yet at the same time factor out the known flags for predictive delinquencies.
Sources: www.prosper.com/ & Bank of Canada.