I started lending money on Prosper about 2 months ago. So far I have 14 Loans outstanding with a weighted average interest rate of 13.96, and a credit rating of A-. Given that I’ve only been at it for about 2 months, I don’t have any defaults as you can see by the chart provided by lendingstats.com

So far my investment in prosper has been more experimental rather than a true investment plan. The question like any investment is the time, capital, and effort worth the returns?

Having learned from other prosper lenders such as LazyManAndMoney. I’ve tended to avoid the high credit risks on the outset. I rather get 10-15% from someone who is a safe credit risk rather than 30% from someone who is a poor risk. As I potentially put more money into my prosper account, I will most likely put more money towards higher risk borrowers. However given that I have only about $2000 to invest, a $50 default shaves 2.5% off my return right off the bat assuming all my other loans are perfect. Once I have more capital to invest and can better diversify my risk then it starts making much more sense to take on greater risk. After discounting for the expected default rate, a higher risk loan should still pay better than a lower risk loan. The other disadvantage of higher credit loans is they are likely to be paid earlier than expected, hence more prepayment risk. Prepayment risk means that as lender you have to find a new place to park that money. This not only exposes lenders to interest rate volatility, but requires more work.

Below is a chart and table comparing the different credit grades on prosper, and historic performance of loans originated between Nov 1st and June 12. I’ve also used the average interest rate on loans from the last 30 days for amounts between 5k and 10k as a proxy of what the prevailing rates for each credit group to calculate an effective rate of return for each credit class.

As you can see the lower credit grades should return a much better profit even taking into account the expected default rate with a much lower prepayment risk. However one thing this analysis doesn’t tell me is how the default rate varies with the interest rate charged. I would expect the higher interest rate, the higher default rate. Ideally I would be able to slice the prosper data by interest rate charged as well. I have yet to figure out how to do this quickly and easily.

If I were able to achieve the Experian ROI of 11.52% (which is the interest rate discounted by expected defaults) that gives me a return of approximately 6.5% above my risk free rate, the 5% return I’m able to achieve via my online savings accounts. Is this 6.5% return worth my time and effort? I’ve sunk in approximately 4 hours building my prosper portfolio of about $1000 worth of loans, to achieve $65 of additional profit for the year. According to my WACT model, I’m basically getting paid around $16.25/hour for my efforts. It’s OK, but certainly not the best use of my time. It’s not like I love bidding on loans.

To really make prosper pay, I believe I’ll have to automate the process via standing orders.  Standing orders are bids that are automatically made on loans as long as they meet the criteria that’ve been outlined (i.e. credit grade, debt to income ratio, etc) Currently I’m a little hesitant on doing so because I feel the real advantage anyone has on prosper is being to personally evaluate a borrower’s story.  That said once I get a better feel for the system, I will proceed to standing orders.