There is a historic new method for investing one’s money. Even more incredible is that it is one of the few financial instruments available to individuals and not to Wall Street*. The average annual yield matches the average annual yield of historic stock market averages such as the S&P 500, without the risk premium investing in equities usually carries.
I am talking about peer-to-peer lending. Borrowing networks implemented by Prosper and Lending Club** allow borrowers to sidestep Wall Street banks and directly obtain loans through investors. I’ll let this guide do most of the talking, but the three word summary I would use is: Microfinance For Americans. Or… Torrents With Cash.
You can start investing with as little as $25. I currently have $1000 spread over 30 people or so. A simple EFT from your bank account will get your bankroll started and from there you can obtain data on various borrowers and decide how much you would like to give them (in multiples of $25). The principal you provide to a particular borrower is low, so if they (in rare cases) default or are late it is only a small amount you lose. The borrower obtains his/her full loan request (from $1000 – $25000) because there are thousands of investors doing the same thing. Also Lending Club does a great job prescreening borrowers to limit the pool to creditworthy, low debt-to-income ratio people.
A few things to consider as you select your borrowers.
(You are allowed to ask them specific questions related to finances. Not all of this information will be provided.)
1. Debt-to-income ratio.
In some cases you will need to break down the kind of debt, especially in the case of debt consolidation loans. i.e. what part of the debt is HELOC (home equity line of credit – scourge of the 21st century) what part are student loans, what part are credit cards, etc. You don’t want to be fueling a debt binge.
2. Monthly payment-to-income ratio.
Can the person taking out the loan afford to pay you back given his/her income? Compare the monthly payment to monthly mortgage/rent. It helps to have your own budget – what is your rent/income ratio? Would you be comfortable making another monthly payment of the proposed amount?
3. Credit score.
A credit score is like an SAT score – it helps if it’s higher, and a low score can flag you to inspect more closely.
4. What is your risk tolerance?
Lending Club has great statistics on returns of loans of various risk categories. Determine what you are comfortable with and invest in the appropriate groups. Lending Club assigns these groups based on borrower creditworthiness and inherent risk in the proposed use of funds (e.g. startup funds will be riskier than debt consolidation).
5. Job.
It helps to understand the stability of the income source of the borrower. How long have they worked for the employer, who is the employer, are they stable, etc. During recessions and such this is even more critical.
I think this is a fantastic new development that empowers individuals to take control of their own finances on both ends. This is a win-win situation for everyone involved, which is rare, especially when it comes to money. Lending Club has much lower overhead than traditional banks, keeping rates for borrowers low and returns for investors high. And it may be more satisfying to your remaining shreds of humanity to earn your returns from helping individuals succeed rather than corporations.
*What’s stopping Wall Street from fucking it up? This game is too small for their bags of cash. Simple as that.
**Disclosure: I am a member-investor of Lending Club. I can’t speak for Prosper.