At the end of 2021 I received my year-end bonus and, when all was said and done there was about $2,000 left over to do whatever I wanted. A smart person might invest this windfall while an adventurous person might plan a vacation or purchase some sporting goods. Instead, I decided to explore a long-held interest of mine: microloans.
Microloans
Typically when we think of loans we picture visiting banks. Usually when a person takes out a loan they are borrowing thousands of dollars from a centralized institution, such as a bank or credit union. The money might be for a house, a car, or debt consolidation. The borrower then pays back the money at a low interest rate for several years. A microloan is a similar concept on a smaller scale. With a microloan the borrower wants a small amount of money, perhaps a few hundred dollars, and plans to pay it back within a few weeks or a few months.
Why might a person want a microloan? Typically microloans are sought by people who do not have a lot of credit with financial institutions and need small amounts of money to overcome a specific challenge. A person might seek a microloan to buy a bicycle in order to start working as a bike messenger. Another might have been hired for a new job, but needs to purchase fuel and groceries in order to get to work in order to collect their first paycheque. Microloans are typically given quickly, in small amounts, with the promise of a quick turnaround.
The idea of microloans interested me, especially in view of how entrepreneurs in developing nations were using them to get small businesses off the ground. However, the concept has not really taken root as well in North America, or at least that had been my impression. I was curious to explore and see if I could become involved in microloaning and I found an opportunity.
Peer-to-peer lending
A close cousin to microloaning is peer-to-peer loaning. While we tend to think of most loans as being between an individual borrower and an institution who is loaning money, peer-to-peer loans are less formal. If you’ve ever borrowed $5 from a friend for lunch money, you’ve engaged in a peer-to-peer loan. It’s a transaction between two individuals, one which also usually involves small amounts of money exchanging hands with a short payback window. I stumbled upon a corner of the Web where people were engaging in peer-to-peer microloans.
To the Internet!
This section of the Web, which has asked to not be named specifically, lives on the popular social networking site Reddit. Through this forum, people from all over the world (mostly North America and the United Kingdom) can gather and place requests for money. Typically a person seeking a loan posts a request stating the amount they need, where they are from, and when they can pay back the money. They may also mention what payment services (such as Venmo or PayPal) they use and, optionally, how much extra they’re willing to pay back.
People who wish to help can then respond to these requests, ask for more details or information to confirm the request is legitimate, and get contact information regarding where the financial transfer should be sent. If all goes well, the borrower will pay back by their self-imposed due date, possibly with a little extra money as a thank-you to the lender.
The experience is entirely unregulated, done almost entirely person-to-person, and is founded on the idea that most people want to be cooperative. The theory is that some people will put forward money, mostly out of the goodness of their hearts, and borrowers will pay back their loans on the honour system to keep the community functioning. I was curious to see how it would work in practise.
I read the forum rules, which mostly boiled down to “play nice, don’t harass people” and spent a day or two observing how the process worked. In short, one person would request money, often another would offer to loan them the funds, and this information would be recorded publicly on the forum. Then, assuming the loan was paid back, this information was appended to the forum thread. When loans were not paid, for one reason or another, a new post would be made indicating this default had happened and the late borrower would no longer be allowed to make requests on the site.
The forum has automated software which helps track past and present loans, the amount of money a person has loaned and borrowed, and how many loans have been completed successfully or entered default. A quick survey of the information available on active lenders showed between 80%-90% of people were paying back their loans and, on average, most lenders paid back their loans with a bonus of between 10%-20%. In other words, most lenders were probably breaking even or maybe making a small profit.
The experiment begins!
In January 2022 I decided to dive in and, after browsing the latest requests of the day, made two small loans of $100 and $160 dollars. About a week later these had each been paid back with a bonus and one was accompanied by a kind thank-you note. I then followed up this success with a new trio of loans, each which was returned in a fortnight.
The experiment was going better than I’d expected. In less than a month I had managed to assist five people in accomplishing specific goals or helped meet their needs and not only had my money been returned, I’d received a small profit of about $100. I set up a spreadsheet to track the microloans, recording the amounts paid out, the money returned, and the time of each transaction.
As things were going well I filled a few more loans and, with one exception, they were paid back. I added some more calculations into my spreadsheet, such as working out how much money had been paid out, how much was expected back, and projected returns. At this point all was running smoothly. I decided to dive in a little deeper and embrace the process. Around the start of March I gave out ten new microloans.
My luck turns
It was in mid-March, while looking at my spreadsheet, I found myself thinking that with all these new loans being repaid, I should end up around $500 up from where I started. The projections were looking good. Even if a few people didn’t pay me back (following the 80%-90% pattern other people seemed to experience), I should still be a few hundred dollars up from where I began. It was then that the icy inner voice of cynicism broke into my thoughts and pondered: But what happens if no one pays me back?
Looking at the experiences of others suggested about 80% or more of people on Reddit pay back their loans, but those were averages gained over a few years of time. They didn’t account for streaks of good or bad luck. The numbers I was looking at were statistics based on past performances over years of time – at best a probability of what I might expect, not a fixed pattern. My follow-up thought was more dire: the 80%+ rate of repayment I’d been looking at was from lenders who had successfully navigated this on-line market for multiple years. They were the success stories, not necessarily the norm. I had no data from people who had tried this peer-to-peer form of near-anonymous microlending, because they were gone. They’d tried it, lost out, and disappeared. Only the winners remained and I was basing my projections on them.
Something else occurred to me that day. Up to this point in my life I’d mostly tried my hand at investing – stocks, mutual funds, bonds – things that, even when they dropped in value, I still owned. I could wait for them to bounce back or sell at a loss. With semi-anonymous loans on the Internet, either the other person pays you back or they don’t. There’s no middle ground, no consolation prize. If they don’t pay you back and disappear into the ether of the Net, then you’re out of luck. It was a sobering thought and one which made me take a closer look at my process and my spreadsheet. What I was doing, I realized, was less akin to investing or loans the way banks engage in them – with collateral and insurance to balance loses. What I was doing, with my spreadsheet of averages, projections, and min/max loan values was gambling. Gambling on the combined capability and integrity of strangers to pay back loans to other strangers.
It is, perhaps, unsurprising that eight of the ten loans which came due that week were not repaid. I went from a few hundred dollars of profit in my venture to about $850 in the red. It was a harsh lesson in the nature of on-line peer-to-peer lending.
To make matters worse, my inbox was regularly receiving little waves of spam. Each time I’d offer to fill a loan or receive a payment this was noted on the Reddit forum and, each time, people or bots would see my username and send me requests for money. Typically three spam messages seeking financial aid arrived in my inbox for each post. Handling 10 loans in a week would mean 20 forum posts (one for the loan, one hopefully for the repayment), which meant 60 spam messages a week offering sob stories and demanding cash.
Regrouping
At this point a person could reasonably decide to cut their loses. It had been an experiment which was both educational and costly, but I could walk away now slightly more humble than before. However, I wasn’t ready to do that. I’m a person who likes to seek out patterns and I set about analysing both my transactions and the other publicly viewable ones to see if I could spot winning and losing factors. I examined the rate of repayments from people in Canada vs the USA, men vs women, rural vs cities, east coast vs west coast, people seeking large sums vs people seeking small loans. I hoped finding a trend would help me pick better borrowers. The curious conclusion I came to was: it didn’t seem to matter. As far as I could tell Canadians default at about the same rate as Americans, people are just as likely to fail to repay $25 as $400, city slickers are just as likely to pay back loans as country folk, men are just as likely to skip out on the bill as women. For someone who tends to see patterns in data, even if there is no real reason for it, the lack of a tip in the balance in any of these factors was maddening.
I also read up on the experiences of other lenders and what worked for them. A lot of it was guess work, luck, and things I’d already tried – like asking for proof of income or identification. One key factor though was the use of some kind of insurance. Most money transaction services just send money from one person to another without much in the way of regulation or tracking, probably to keep service fees low. A few will offer the sender of funds the chance to insure their transfer. Which basically means if you pay an extra $2 or $3 you can demand the service reverse the transaction in the future if the person receiving the money has not followed through on your agreement. This required a small fee and some record keeping on my end, but sounded promising. I entered the month of April with a sense of fresh optimism.
Getting back on the horse
I waded back into the Reddit pool of microlending in April, taking things a little slower than I had at the start of March, but still actively engaging. Most of the dozen loans I gave out that month came back to me, repaid in full, with a little extra tagged on. However, a couple did not and they were, perhaps with a sense of appropriate drama, the larger ones. This left me still about $800 in the hole, but gave me a chance to test the refund service concept.
The refund process worked, though the process is slow. In an environment where loans are intended to last a week or two, the process for getting money refunded due to a failure of the borrower to follow through takes around three or four weeks, in total. This meant at the start of May I was getting refunds for money loaned at the start of April. It also resulted in some angry messages and requests for appeals from one borrower who was determined to put up a fight to keep the money, even going so far as to send me private messages to taunt me during the appeal process. Eventually, he lost, I think in part due to the screenshots of the taunts I submitted during the appeal process with our transaction service.
My new approach of taking things slower, entering into about ten loans per month and appealing the transactions borrowers refused to repay was working. Gradually, my spreadsheet was rebalancing itself. I recovered about $600 by the end of May, meaning my experiment was just $200 in the hole in total after five months. Not exactly ideal, but at least things were moving in the right direction. Being down $200 might seem bad, but it meant I was down about 10% ($1,800 of my $2,000 remained). The stock market during this same period was down 15%. So I was losing, but my loans were still beating the stock market in performance – if I’d invested my money at the start of the year I’d be further behind.
Two frustrations with the process remained. They were: 1. the continuing spam messages, and 2. watching my balance climb most of the time, only to have one borrower wipe out my progress, at least until I could appeal. The fluctuations in luck, causing my account to rise and fall virtually at random, was not for the faint of heart.
Wrapping up the experiment
As I drift toward the end of June (the time of writing), I’ve reached the point of approximately breaking even. I may finish the month about $50 up or down, but it’ll be almost back to where I started six months prior. This is an interesting experience and one I will probably continue with, though at a reduced rate. It’s been an interesting journey and I’d like to share some observations and statistics for anyone who enjoys patterns and figures as much as I do.
After the course of my experiment, which lasted from mid-January to (at the time of writing, mid-June), I gave out 52 loans. Just over two a week, on average. Of those, 38 loans were repaid with little to no problems. The remaining 14 either were not repaid at all or, in two cases, were partially repaid. This gave me a success rate of 73%. With a few of the unpaid loans I got the money back from the company handling the transaction once I demonstrated the borrower hadn’t held up their end of the deal.
In total, I loaned out $9,469 – though this figure is deceptive. I actually put a total of about $2,000 USD into a fund and loaned it out, then got it back, and loaned it out again, and got it back in a cycle. In the end I basically got all the money back I’d loaned out, with the interest people offered balancing out the loans left unpaid. The average loan size was $182 USD. The smallest was $28 and, tied at the largest, I gave out two loans of $500. The other 49 fell somewhere in that range, usually between $100 and $200. The amount of interest offered on loans varied quite a bit from none at all, up to 53%. The average interest offered was 23%.
There seemed to be a roughly even divide of men to women, rural to urban, east coast to west coast. Most of the people I did business with were Americans, but a handful were Canadians. Most of them were relatively young (under 35, often mid-20s). None of these factors – location, gender, age – seemed to affect the rate of repayment.
Buyer beware
Something I started to notice a few months in were common scams. I couldn’t determine, based on demographics, who would pay me back or not, but I did start to notice warning signs. People who asked for loans frequently – from one person or multiple people – often didn’t pay back lenders. People who had long stories about why they needed money seemed less likely to pay. The more a person talked about their kids, pets, or medical issues, the more likely they seemed to be hoping emotions would cloud the lender’s judgement. People who gave short or virtually no explanation as to why they needed the money seemed to be more reliable – they treated it as a business rather than a confidence scheme, though even this wasn’t a sure way to separate successful borrowers from those who didn’t pay back.
One scheme I ran into a few times was a person asking for a small loan, paying it back on time, then asking for a large loan in the future, only to disappear. This is tricky because often times repeat borrowers are the most loyal and willing to pay back their debts. A lot of the people I did business with were repeat borrowers and about two-thirds were great to work with multiple times while the other third disappeared, leaving their debts unpaid, after two or three successful past transactions.
A common tip among on-line lenders is to ask for identification and proof of income. I did this for a while, but found borrowers weren’t any more likely to pay me back if they had shared their driver’s license and pay stubs with me than if I hadn’t asked for them.
At points in this venture the experience started feeling like a part-time job. I was fielding e-mails, clearing out regular spam messages, tracking everything in a spreadsheet, sending out reminders to people to pay. A person could probably burn out doing this on a regular basis and, while I may continue doing it, I’d only do it at a slower rate. Perhaps once every week or two rather than three or four times a week, just to cut down on the workload and spam.
In conclusion
On a positive note, there were a few things I enjoyed about the experience. Turning the corner and starting to make money back instead of losing money was obviously nice. What felt better though was connecting with people around the world. I heard from mothers, young people starting their lives, university students, cooks, army veterans, ranchers, and software developers. All sorts of people were out there, looking to connect, hoping for help, and sharing parts of their lives.
Even better was, when a loan went well and the borrower repaid it, I’d often get a nice thank-you message for the help. The people who were doing this, asking strangers on the Internet for money, and doing so in good faith, were desperate when we met and often relieved when our business was concluded. Despite the occasional people who couldn’t pay back a loan (due to circumstances) or the occasional scammer, the bulk of the people I interacted with were friendly, hopeful, and ultimately grateful. I sometimes received nice notes offering to put me up if I ever venture down south, or heard from people who were planning to pay the kindness forward by helping out others, or received messages from people who simply wanted to thank me for assisting in feeding their kids that week.
These were pleasant moments, a reminder that when everything was running smoothly and people were operating in good faith, peer-to-peer microloaning can be a positive, win-win experience. It can help out people who are in a difficult situation and profit the people offering loans at the same time. I like to think this experiment did some good in the world, if only a little.
I also want to acknowledge that, unfortunately, about a quarter of the people with whom I tried to work didn’t (or couldn’t) keep things running smoothly. These interactions did not result in a win-win situation. I think this is unfortunately because this on-line community could be beneficial, can offer inexpensive aid to people who need it, and this community could be an example of how people (even strangers) can help each other. Unfortunately there are enough scam artists in the mix that they muddy the waters for everyone, raising interest rates of the people willing to take a chance on giving strangers money, and driving away lenders who get ripped off too many times. I heard from a few people during my brief experience who gave up after too many of their loans were defaulted on and I think that’s unfortunate. The microlending community should be about mutually beneficial arrangements, and tries to continue being so, despite the few bad apples.
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