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Tuesday
Jul072009

Five things to ask yourself if you are interested in social lending

There is significant buzz around the concept of social lending these days. From the dramatic re-opening and prompt re-closing of Prosper Marketplace, to the calm (and dare I say bank-like?) steady returns of Pertuity Direct, mainstream borrowers and lenders across the spectrum are wondering whether social lending may be a legitimate pursuit. But who is it for? Is it an alternative reliable source of returns for investors? An option for borrowers who seem to have no other options? A platform to lend to the working poor around the globe? A risky, high-payoff avenue for lenders? A way to feel good about helping people reach goals that you support?

The truth is that social lending is an incredible diverse market space. If you’re thinking about entering the social lending sphere, ask yourselves these questions to know which platform may be right for you:

  1. What originally drew you to social lending? I see three main classes of people interested in social lending: 1) Investors looking for an alternative return stream; 2) Idealists looking for a concrete, high-impact way to contribute to social good; and 3) Casual lenders intrigued by the possibility of cutting out the bank to earn returns and create a more transparent financial experience. You should know immediately which type you are—investor, idealist, or casual lender—and your options will narrow considerably based on these goals.
  2. How much personal connection are you looking for? As the term “peer-to-peer lending” has evolved to the broader “social lending”, some sites are moving away from the direct p2p connection. Pertuity Direct, for example, has very consciously tried to move to the mainstream lending market by relegating the typical “borrower profile” to an optional community page. Instead, lenders buy into a pool of borrowers of a given asset class. This approach is excellent from an efficiency standpoint—no need to browse through profiles to try to create your own diversified portfolio—but the lenders looking for the feel-good sensation of getting to know your borrower will be disappointed. Lending Club offers the more traditional profile-browsing approach which gives you a direct connection to your borrowers. On Kiva and Microplace, you choose a microfinance institution who finds individual micro-entrepreneurs according to filters—in your chosen country, target demographic, etc.—whereas on LendforPeace, the entrepreneurs are all Palestinian. Through Virgin Money, you simply formalize deals with people you already know; no new relationships are gained, rather the site creates the framework to help prevent existing relationships from deteriorating when they are complicated by a financial bond. The latest entrant Unithrive connects Harvard alumni with current Harvard students – the possibility for a durable bond between individuals is there with both the financial and university connection.
  3. How much risk are you willing to take? Initial challenges with high default rates when the p2p lending space was in its infancy led to many charges that borrowers on these platforms are an adversely-selected population and lending is risky business. The industry has made great strides since then and has instituted far more stringent borrower requirements, but the risk factor is still relevant. Pertuity Direct and Lending Club are the only two companies that are registered with the SEC, so if the government’s blessing matters to you, your options are quite limited. The international microfinance sites have very low default rates (1.7% on Kiva). Pooled lending, like on Pertuity Direct, achieves the highest rate of diversification, but if you’re willing to accept the risk, you can choose borrowers paying a higher interest rate based upon their profiles at Lending Club. Prosper is still shut down, but many early lenders were burned on the site – often due to their own lack of judgment, but an issue nonetheless.
  4. Do you want to make money? At Kiva and LendforPeace, p2p microfinance sites, you earn no interest, but the sites offer a high-impact way for you to park additional money (as little as $25). At Microplace, you can earn up to 6% interest (although most investments fall more in the 1-3% range). At Pertuity Direct, the average interest rate is around 13.4% (minus fees). Lending Club claims a 9.05% average annual performance.
  5. Are you interested in a particular cause? Many sites target very niche markets. If you are appalled by the usury of payday lending, check out alternative Yadyap (“payday” spelled backwards). Passionate about education financing? Look into People Capital or Unithrive. If you are looking to provide economic opportunities in Palestine, LendforPeace is your site. To help mainstream American families, Prosper and LendingClub are the best known.

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Reader Comments (10)

Despite its problems, Prosper worked pretty well, except strangely enough people were willing to accept a very low return particularly on very high risk loans like real estate and small businesses. This happened despite the fact that Prosper's own return calculator predicted negative returns.

Now that there is more lending competition, it will be interesting to see what happens. As our record for excess has shown, there will be winners and losers.

Great reporting, your social capital just increased by 10%. Perhaps not a great return short-term, but in 10 years you should be a billionaire and living on the Riviera, according to my quick calculation.

July 8, 2009 | Unregistered Commenterecogordo

I find the comparative analysis in this article/blog to actually be fairly detrimental to the reader. First off, comparing all of these organizations together, solely on the basis to their association to a microfinance platform is irresponsible. This would be like comparing Apple, AMD and Sony together solely because they are "Technology" stocks. I would be embarrassed making such a comparison to friends or colleagues.

Kiva is nothing like MicroPlace, and MicroPlace is nothing like Prosper. Kiva is purely a donation site, a charity of sorts. And while no one can donate everything they have to charity (as that would amount to wealth transfer and not wealth generation) it makes sense (and is actually healthy) to have charitable donations within a portfolio. MicroPlace is not a charity, its an investment site. So, while I maxed out my charitable donations on Kiva, I can mobilize my savings to impact the working poor by investing my savings in MicroPlace listed securities. Great, the best of both worlds.

Prosper offers P2P lending at above market rates. Unlike MicroPlace, there is NO prospectus. No protection from borrower default in the form of Loan Loss Reserves by the sponsoring organizations on MicroPlace (called "Issuers"). So Prosper is purely speculative. There is nothing wrong with speculation, as it too is a healthy component of a portfolio (depending on your investment time horizon and if speculation is determined to be acceptable within your risk philosophy).

All three of these are very different from one another, and cannot therefore be compared to one another. These differences, as stark as stocks vs. bonds, play a different role in your portfolio. And we ALL maintain a portfolio, whether you acknowledge it or not it is there, it exists and your spending and savings habits determine its success.

I hope this sheds the needed light on this subject and introduces a more responsible perspective on the differences within the microfinance space.

July 8, 2009 | Unregistered CommenterConcerned Observer

@ecogordo I agree that much of Prosper's initial challenges arose from irresponsible lender decisions -- expecting high returns without a proper evaluation of risk (a practice we've seen before!). Thanks for the optimistic forecast :)

@concerned All of these sites are self-described "p2p lending" or "social lending" platforms. I do not, as you suggest, connect them all to the microfinance platform. The purpose of this article was to highlight the key differences between sites that all claim to be part of the same space. Kiva and Microplace are remarkably alike -- lenders in the US (primarily) can make small loans to entrepreneurs in developing countries. I highlight the differences: 1) interest vs. donation and 2) direct p2p lending vs. lending though an NGO. That does not make them so fundamentally different that they don't deserve to be compared or to claim that they are "nothing alike". You do mention some additional differentiators, such as that Prosper does not offer a prospectus. This is true, but it is still p2p lending. It would be silly not to compare things simply because they are not exactly alike -- in that case, what's the purpose of the comparison?

July 8, 2009 | Unregistered CommenterMelody Hildebrandt

@ Melody
Point taken.

Perhaps it is the industry I operate within, but comparing donations to any interest bearing security is not kosher and literally doesn't work. They deserve to be compartmentalized, so as to properly allocate their due risk. They are functionally different, regardless of their perceived connection. But you are correct, there is not point in comparing items that are already alike. I would just encourage greater discretion.

July 8, 2009 | Unregistered CommenterConcerned Observer

@Concerned Thank you for the thoughtful comments. I very much agree that these items operate in a very diverse space, but since they define themselves in similar ways, I think that it's worth looking at where they converge/diverge. I, too, struggle with some of their self-definitions, e.g., is Pertuity Direct really a "social lending" site if lenders are simply buying into a securitized pool of loans? On the other hand, Kiva is trying hard right now to be able to offer interest-bearing loans, so the lines sometimes blur.

July 8, 2009 | Registered CommenterMelody

Thank's for this post! I found that from a decision-making point of view, the structure of this analysis is very helpful. Being able to ask myself questions as I think about social lending is especially user-friendly and better than some other comparisons that just list the differences. I already know which one is the one for me! (MicroPlace).

Concerned reader, I can see how these all can fit into a portfolio strategy. It makes me think I shouldn't pick one but diversify? If only i had the money :)

July 8, 2009 | Unregistered Commenteranonymous

40billion.com is a great one to add to the list of niche peer-to-peer players. It's the first p2p focused on funding U.S. small businesses and entrepreneurs, addressing the $40 billion funding gap. For those passionate about business financing, 40billion is all about people funding businesses.

July 9, 2009 | Unregistered CommenterJanie Johns

I think the difference is that "things you need to know about social lending" has an industry focus, whereas consumers think about charity and investing very differently. The fact that social lending lumps the two together can be confusing. If you're trying to answer the question "which platform is for you", then the primary question is whether you're looking to help people or make money (or do both). This question is so primary that "which platform is for you" doesn't make a lot of sense. Rather, the question should be "which charity social lending platform is for you" or "which investment social lending platform" is for you.

July 10, 2009 | Unregistered CommenterTim

I was clear when I started lending on Prosper: my goal was to make money while helping others. I quickly fell for sap stories and deviated from making money and indeed lost some. Then I moved to LendingClub, where I stay away from the stories, but invest in loans that make sense numerically (priced right, risk looks reasonable, story fits the credit profile, etc). I've been making 9% after a year and a half... highly recommended.

July 14, 2009 | Unregistered CommenterLending4Profit

Lending4profit: I think your story offers some important lessons. The personal story aspect of these p2p sites can be quite misleading. Your strategy of picking the right investments based on more objective criteria is right on.

July 15, 2009 | Unregistered CommenterMelody Hildebrandt
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