Peter Renton on P2P Lending: Are You Asking the Right Question?

May 11th, 2012 by

By Peter Renton from Lendacademy.com

Let’s get this out of the way from the start. I am not going to say Lending Club has better returns than or vice versa. I think that is the wrong question to ask.

Obviously, we all want the best returns possible and like any investment we can study historical returns to determine which company or fund has produced the best results. But what does that mean for results going forward? Not much.

Here is one statistic that every investor should ponder. According to Lendstats, the average interest rate on all loans issued since January 1, 2010 is 13.1% at Lending Club and 20.3% at Prosper. That is a 7% spread.

So the better question to ask yourself is how much risk are you willing to take?

Obviously Lending Club has a lower risk portfolio because the average borrower there pays a lower interest rate. We also know that Lending Club has tighter underwriting standards that go along with this. A borrower must have a FICO score of at least 660 in order to even be considered for a loan at Lending Club.

Prosper has done an excellent job at producing outstanding peer to peer lending returns since they reopened from their quiet period in July 2009. They allow a higher risk borrower, on average, on to their platform and so far these borrowers are holding up very well. So, Prosper provides the opportunity for an investor to earn higher returns. But like any high risk/high reward investment there are potential downsides. If the economy goes back into recession it is possible that the borrowers on Prosper will suffer more and returns may decline from their current levels.

What I Recommend: Diversification

I believe that everyone who is serious about p2p lending should open accounts at both Lending Club and Prosper and invest in a broad cross section of borrowers. This provides diversification not just between companies but also among different kinds of borrowers.

If the economy continues to perform well investing in the higher risk borrowers should provide above average returns for investors. And if the economy tanks again investors will likely be glad they also have some low risk borrowers in their portfolio.

Over the next couple of years Prosper loans may perform better than Lending Club or vice versa. I really don’t know. But I am confident that the asset class as a whole will continue to provide excellent returns for investors.

Peter Renton is the publisher of the Lend Academy, a blog focused on the peer-to-peer lending industry.

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