Prospering through microloans?

Lately, I've been lurking on Prosper.com from time to time. At first, I was simply trying to figure out how the whole thing works. It's been described as the E-bay of loans: People who want to borrow money set up profiles, and lenders bid on the loans that look like good bets. Each bid drives the interest rate for the loan down just a little bit more, and once the borrower's requested loan figure has been fulfilled, the lowest bidders up to the amount of the loan are locked in. These bids are combined into a single three-year loan for the borrower, and payments are deducted from the borrower's bank account on a monthly basis so that lenders can be repaid. The verification statuses of home ownership and bank account information for each borrower are visible, as are the borrower's A through HR credit rating and debt-to-income ratio. Only registered lenders (disclaimer: I'm not registered) can see the borrower's actual credit score. Go to the website yourself or Google it for more information on how it works.

The stories on Prosper.com interest me. They run the gamut from go-go business owners looking to expand their enterprises to people looking for a last-ditch salvation from insolvency. I thought it would be interesting to see a sample of what kind of loan requests are out there, so I did a little experiment. First, I pulled up the full list of loan requests. Then I sorted it by credit rating. I decided to look at five profiles from each credit rating. I wanted to use some sort of quasi-scientific methodology so that I didn't just look at profiles with catchy titles or photos, so I decided to go to the first item listed for that credit rating, count down to the twelfth item, and look at the details for that profile only. I looked at every twelfth profile within each credit rating until I had a total of five for each credit rating; at that point, no matter how many profiles were left for that credit grade, I moved to the next credit grade. I also counted AA and A as one category, since I ran out of AA's quickly.

I made some notes on each profile. While doing this, I tried to keep them generic enough to make the profiles I reviewed not altogether easy for blog readers to find. I also decided to take the full contents of every profile at face value, since I have no way of personally validating any of the claims.

My notes are below, and after that you'll find a writeup of some of the interesting things that jumped out at me upon reading them.

AA: Loaned money to brother to go back to school and consolidate revolving and charge accounts; legal contract in which interest rate is tied to grades. Wants to borrow $10K to fill up cash void; expects to benefit from the spread (seems to expect brother to do poorly in school). Also looking for $10K to invest in rental real estate.

AA: Expand and upgrade profitable side business. Prefers to borrow rather than spend own money because of interest rate spread between loan and investments.

AA: Borrow money to buy fitness equpment for personal training. Director of a fitness and nutrition website; seems to be opening own business, although not explicitly stated.

A: Borrow money to finish remodeling home in preparation for sale (moving out of state for a new job).

A: Repair money to flip a house. "Automatic money" coming in every month (no further explanation).

B: Pay doctor's bills. Homeowner either has cancer or a family member has cancer; not all medical bills covered by insurance.

B: Borrowing to pay credit cards. Gross income of over $100K annually; two-earner household. Borrower has student loans. Homeowners with additional land and 401(k); borrower plans to attend medical school at unspecififed date.

B: Pay off debt (type not specified) other than car loan. Career military; long-term goal is to open a restaurant/bar in Okinawa, Japan.

B: Consolidate bills: student loan, medical, dental, hard money loan. Several years out from bankruptcy, which was caused by spouse's heart attack and subsequent medical bills.

B: Complete home improvements. Borrower says s/he is a good candidate for repayment because s/he has never been late on making payments on mortgage.

C: Wants to borrow money to become a yoga instructor. Paid off over $25K in credit cards in six years; current debt is a small (< $1000) school loan and a car loan.

C: Pay off high interest loans. Source of income is SSDI. (No other information.)

C: Pay off high interest loans; avoid foreclosure. Borrower was previously employed but became disabled; receives disability payments. Went bankrupt because of divorce. Started working in a different field [NOTE: what about disability?? New job has similar physical requirements to old job]; developed a chronic illness and is no longer able to be around the chemicals used at the new job. Husband required partial amputation; developed severe infection and was unemployed for five months. Husband has returned to work full-time.

C: Purpose of loan unspecified other than that bill-paying has become tough since the arrival of triplets.

C: New business opening in a few weeks; business funded with credit cards. Loan is to pay off credit cards, buy more inventory, and build up cash reserves. Business is a retail storefront; before investing in a brick and mortar location, borrower sold inventory at flea markets.

D: Consolidate credit cards and student loans. Two-earner household; debt incurred when one adult member of household went back to school to make a career change.

D: Wants to buy a stove off of Craig's List to reduce home heating bills. Already has money in savings, but it is earmarked for Christmas; doesn't want to touch retirement acounts. Two-earner household; has never made late payments.

D: Wants to pay off two loans (sources not specified). String of bad luck: dog died, father died, ex-husband wrecked vehicle and departed. Has a stable job; honest and dependable.

D: Consolidate debt (sources not specified). Self-employed; stable industry, but there are general and unexpected expenses from time to time.

D: Buy laptop to pursue accounting degree. No late payments; one ding on credit report was put on by accident and is in the process of being disputed and resolved.

E: Pay off payday loans. First incurred payday loans when helping father with medical costs. Employed full-time; also starting part-time job soon.

E: Fix up home purchased for investment. Does most of the work personally. Previously had excellent credit; business went under after 9/11. $10,000 in savings; spouse is employed full-time.

E: Pay off payday loans and credit cards. Spouse had sa troke while borrower and spouse were overseas (unclear why or how long couple was abroad); borrower was not working at the time. Debt is not specifcally described as medical debt.

E: Pay off credit card debt. Debt became overwhelming when spouse experienced a career change.

E: Clean up credit report and pay off payday loans. Spouse became catastrophically ill; borrower used credit cards to pay medical bills. Filed for bankruptcy to save home; cannot get credit now. Borrower also used payday loans for child's college education because borrower was ineligible for student loans because of negative credit.

HR: Become a certified RV tech to offer affordable RV repair to retirees. Borrower is retired; borrower and spouse live and travel in an RV. Both receive retirement income (type unspecified).

HR: Fix or replace vehicle for lawnmoving/snow removal business. Additional income comes from military retirement.

HR: Buy laptop for school. Borrower works when not in class. Borrower has student loan; payments are deferred until graduation.

HR: Reduce lower-balance credit debt. Borrower has worked consistently for eighteen years. (No other information.)

HR: Pay airfare and funeral costs for deceased father. Borrower is executor of father's estate; expected to pay for funeral through the sale of father's house, but the sale fell through.

Here are a few observations that jumped out at me right away.

1. Borrowing to pay consumer debt
Two of the E requests specifically referenced payday loans. One of the HR requests, two of the E requests, two of the D requests, one of the C requests, and one of the B requests specifically referenced credit cards.

2. Borrowing to make money
One of the HR requests, one of the E requests, one of the D requests, one of the C requests, and all five of the AA/A requests are geared towards starting a business or increasing the income stream of an existing business.

3. Borrowing for education
Two of the HR requests, two of the D requests and one of the C requests are to fund education, special training, or equipment for educational purposes.

4. Borrowing for medical bills
One (possibly two) of the E requests, one of the C requests, and one (possibly two) of the B requests represent borrowing for medical bills. (There is overlap with 1. Borrowing to pay consumer debt because in a couple of cases it's unclear how much of the credit cards/payday loan debt was caused by medical bills.)

Take this analysis with about a pound of salt, folks. Five sort-of-random samples of each credit grade is not enough to prove statistical significance, so there's not enough evidence to identify genuine positive correlations of trends by credit rating, or even overall trends. It's possible to make a few general statements based on this sample, though. These are the ones that come to mind:

1. Credit cards are useful, but only when used wisely.
Relying on consumer credit is a dangerous game. If you live too close to the edge of your means, one major injury, illness, or unexpected income loss can knock you into the consumer debt canyon.

2. Payday loans are downright dangerous.
I don't think payday loans are inherently bad, but they're a bad choice for a lot of people. Interest rates on payday loans are beyond ridiculous. In many cases, the loans are made with the expectation that the borrower won't be able to repay them and will instead roll them over into new loans, incurring all kinds of high-interest finance charges in the process.

3. Insurance is a need, not a want
All it takes is one not-so-major illness or injury, and uninsured or underinsured people can find themselves in bankruptcy court. This is a problem that's getting worse almost by the day. Regardless of how the next presidential election plays out, I'm not optimistic that universal health care in the US will happen. Insufficient health care is bad for everyone: inadequate care for the uninsured or underinsured has a ripple effect across the entire public health spectrum because it puts all of us at greater risk for communicable diseases.

4. Debt is a good thing in the right circumstances
Debt is good if it leads to an improved future income stream (like education or expanding a business). Debt is good if it leads to an ROI that wouldn't otherwise be possible to get. Home ownership is a good example: real estate usually appreciates over the long term, but very few people can afford to buy a home without financing. Bad debt is debt that doesn't lead to financial gain.

5. An emergency fund is critical
I noticed more than a few instances of people going into high-interest debt because of unplanned events. The most powerful way I know of avoiding the credit card/payday loan trap in emergencies is to build up a cushion of money to respond to the unexpected. It takes discipline and time, but when you consider the alternatives, making sacrifices for a rainy-day fund sounds a whole lot better.

I don't know if Prosper.com is a good investment vehicle for lenders or a good source of funds for borrowers; I haven't spent enough time with it to get a good feel for the upside (or downside) potential. If you've had experience with it one way or another, I'd love to hear how it went.