In the never-ending quest for diversification (hopefully with a decent return), I’ve moved towards one of the newer asset classes out there: peer to peer lending.
The idea seems simple enough, yet quite possibly very risky and not as diversifying as some (OK, caveats completed). Most personal loans are made by banks (duh), who have been cutting back on credit since 2008. There’s a good reason for that – they massively overextended, due to low rates and competitive pressures – so seems a good reason to not lend to any and everyone. However there’s a bad reason for that – the voluminous new rules (e.g. Dodd-Frank) which have led to much worse risk-weighting of bank assets. That means not as much lending supply to those who are *probably* good credits.
Enter P2P. Here’s the way I think of it:
- The good scenario: someone working in a cyclical industry (e.g. construction) had a tough time during the downturn. Maybe went delinquent on a credit card bill a few times. Didn’t declare bankruptcy, and managed to get back to paying on time. However, now his credit score is too low for the banks to touch him when he wants to consolidate debt. He wants to consolidate his credit card bills into one (amortising) loan with a 3 or 5-year maturity. His interest rate goes from 20% or so to around 15% or so. I’d probably take this credit.
- The bad scenario: someone unemployed, or newly employed, wants to redo his house. Hasn’t had credit before, and wants a loan that is a high % of his income. I don’t like these odds because of the unknown.
Anyway, I’ve chosen Prosper to begin the P2P adventure. The site has been around quite a while, and looks to have good returns on seasoned loans. I like the $25/loan minimum, which means I can diversify my credit risk pretty widely. The loan listings are fun to peruse – I get to see plenty of borrower info, loan terms, etc. And when I’m done allocating to loads of loans, I plan to use the automated investing feature and/or the API (NB: as these loans are amortising, you have to keep lending to ensure you keep generating returns).
In sum, I’m trying this out with a small amount of capital. Hopefully the returns I get are similar to the overall market – e.g. much better than bank accounts and corporate bonds, but with likely credit risk similar or worse than high-yield corporate bonds. It’s ultimately a bet on US recovery or status quo; even a well-diversified pool of loans will get smashed in a 2008 scenario.