Back in June I talked about exploring one of my interests, specifically diving into the world of peer-to-peer lending. In my experiment I was making small loans (called microloans) directly to strangers I connected with through the Internet. The experience was interesting, educational, occasionally stressful, and ultimately marginally profitable. (After six months, I had made about $200.)
In my overview of my lending exploration, and in the Q&A session I wrote after the experiment, I talked about some of the problems I had with the unregulated, direct, peer-to-peer lending experience. These were, in chronological order:
- It takes time to dig through the relevant forum posts to find people who match my criteria – compatible payment processors, borrowers looking for loans within my budget, people who have stated their requirements clearly.
- It also takes time to verify people’s information. There is a certain amount of back-and-forth in talking with people, trying to get a sense of who they are, confirming they have income which will allow them to repay loans, and getting their payment processor information.
- I need to keep track of the loans I have given out. To whom did I send money, how much, when, and when did they say they will repay? All of these bits of information need to be tracked somehow for each loan.
- When a borrower is late paying back money, then there is a period of renegotiation, maybe disputing the issue, and recording the process.
- After each money transfer there is a public record of the transaction which brings out the spammers and scammers. In my original overview of my experiences in peer-to-peer lending I mentioned each loan requires at least two public transactions (one to send and one to receive funds). I typically received three scam messages trying to get money out of me for each transaction. Which means six scam messages per loan, on average. After completing 50 loans that’s 300 scam messages. It’s a constant annoyance.
None of these issues are, on their own, a deal breaker. It is still possible to have fun, possibly help people, and in some rare cases even make money from the public, unregulated peer-to-peer process. However, I kept finding myself thinking that it would be nice if there was a better marketplace for this kind of experience. One where the information borrowers shared was formatted and consistent. One where most of the loan tracking was automated. Perhaps one in which harassing private messages couldn’t be sent to lenders. I especially liked the idea of making it possible to break down big loans into smaller chunks so each lender could reduce their exposure by loaning a tiny amount to ten borrowers instead of one big loan to a single borrower.
As it turns out, I was not the first person to see the need for such a marketplace and take action.
The solutions
There have been a number of attempts over the years to construct a web-based market where people can request money and received funds from multiple lenders (lenders are often called “investors” on these websites). The idea is most loans will be paid back, with interest. This means each lender gets a small bonus with each loan paid back and, since their money is spread out over many small loans (much like stock investors spread their portfolio over many companies), there is relatively little risk.
A handful of these online markets have grown up over the years. Some have gone out of business. Others have transitioned over the years – moving away from purely peer-to-peer loans to becoming brokerages for borrowers to find good loan products from large financial institutions. Others have closed the door on small lenders, choosing to only let large companies (such as banks) provide loans to borrowers.
In short, most loan marketplaces either fold or get taken over by larger businesses who want to direct borrowers to their own products and backers.
As far as I can tell, there are just two reputable peer-to-peer web-based loan markets currently running in North America: Prosper in the United States of America and goPeer in Canada. Each marketplace appears to only allow loans to take place between residents of their home countries, probably for regulatory reasons.
The benefits
I signed up for goPeer which basically acts as an open market for individuals who want to borrow or lend money. The idea is people who wish to borrow funds sign up, state how much money they wish to borrow, and pick a term length (typically loans last 36 to 60 months, but some are shorter). The goPeer service then collects information from the borrower, getting their location, income, credit rating, and some other key factors.
Other people sign up to be lenders (also called investors). They can browse the available loans. Loans can be sorted by purpose, amount to be borrowed, length of term, interest rate, and credit rating. A lender can then choose to “purchase” part of a loan. What this means is when one borrower might want $10,000 they don’t need to find one lender to provide this amount. You could have 100 different lenders all offer to pitch in $100 to cover the whole $10,000 loan.
Once the loan has been filled by one or more lenders, goPeer collects and sends the money to the borrower. Then, starting the following month, the service collects monthly repayments from the borrower and divides it up appropriately between the lenders. goPeer takes 1% of the profit from interest payments for itself and distributes the rest to investors who put up money for the original loan.
Most of the core components when using goPeer are the same as the open, purely peer-to-peer process I was using earlier in the year. However, for its 1% commission, goPeer does a lot to make the lending and repayment process better.
When using goPeer the research part is all done up front. The borrowers fill out forms and goPeer collects data such as their income and credit rating ahead of time. The lender doesn’t need to do any of this work.
The goPeer service works with all major banks, cutting out the need to find matching payment services such as Vinmo, PayPal, or Zelle. All the transactions are handled through goPeer. This also removes the concern of giving a stranger our payment processor information as it is hidden (from both sides) by the goPeer service.
I don’t need to maintain a spreadsheet to track loan information – how many, when they were issued, and how much money was given to each person. The goPeer website has a portfolio page which automatically tracks all of this for us.
Likewise, goPeer handles reaching out to borrowers who are late on payments and works with them to get payments back on track. This takes one of the biggest hassles out of the equation for lenders as it means I don’t need to follow-up with people or fight with their payment processor to try to get back money.
Finally, the process of requesting and providing loans is done fairly privately. The goPeer service doesn’t give contact information to any of the people involved (investors or borrowers) and none of the transactions are recorded publicly. From the user’s point of view, the experience is fairly anonymous. This means no spam messages and no scams coming into my inbox each day.
In short, goPeer (and Prosper) have taken the peer-to-peer lending model and basically set themselves up to facilitate the experience. They take a small percentage of each loan’s interest, but in exchange they make the experience smooth, anonymous, seamless, and track all of the information involved.
The drawbacks
Despite my obvious appreciation for these marketplaces, this isn’t an advertisement; there are limitations with tools like goPeer. For example, almost all of the loan sizes are measured in thousands of dollars and the length of loans is typically measured in years. Most goPeer loans last for three to five years, though they do have a new line of high-risk, short-term loans. My point is that people lending money (or borrowing funds) need to be comfortable being in the marketplace for the long-term.
With direct, unsupervised peer-to-peer loans on the open market people can set whatever rules and timelines they want. Using a marketplace like goPeer or Prosper means using their fixed, usually long-term timeline. It also means using their loan size limits. On Reddit people can ask for or fulfill a loan of any size and interest rate. When using goPeer loans are almost always in the $5,000 to $25,000 range and the interest rate is based on the person’s in-house credit rating. The interest rate tends to vary from about 9% for low-risk loans up to around 30% for higher risk loans.
Though the cost is low, these marketplaces do take a percentage of the profits. It’s a decent business model, and the low rate is probably a good trade-off for everyone involved, but it’s worth remembering there is a middle-man in this scenario taking a fee.
In short, the goPeer (and Prosper) experience includes a lot of conveniences – automated tracking of loans, information collection done up front, privacy, easy banking transactions, they handle collections, and the loan purchases are convenient. However, it means getting streamlined into the marketplace’s rates, limits, timelines, and fees. To me it feels like a good trade, but for people who want more of a “wild west” feel goPeer might be a bit confining. In particular, people who want small loans on a short timeline ($200 to be repaid in two weeks, for instance), these marketplaces will seem slow and restrictive.
The experiment
I’ve been using goPeer for about five months at the time of writing. The user interface is nice, the documentation is a little sparse, but clearly written, and the whole process is quite straight forward. I especially like there is a tool called “auto invest” which will monitor the marketplace for new loans and automatically invest in them if they meet our criteria. For example, I can say I only want to invest $50 in low-risk, “A-rated” loans and the system will do that for me.
Speaking of ratings, goPeer relies on a rating system. People who have well paying jobs and good credit ratings are given an “A”, people struggling a bit financially get a “C”, and people who are likely to have trouble paying back loans have an “E” or “HR” (high-risk) rating. The low-risk loans have smaller payouts (around 9% or 10% per year) while the “E” loans have a 25% to 28% annual interest rate. While the high-interest loans are tempting, they also carry a higher risk of non-payment, balancing them out.
When I signed up I was still engaging in my Reddit experiment. Since Reddit was a high-risk and high-interest environment, I decided to go the other way with goPeer and settled into a low-risk and low-payment approach. I chose to only loan to borrowers with A and B ratings, giving me a return of 9% to about 13%.
To date, after five months of experimenting and engaging in 88 small loans on goPeer, I have an average interest repayment rate of 11.5% (after goPeer takes its 1%). So far no one has defaulted on their loans, giving me a (to date) 100% success rate.
For comparison’s sake, of the 56 loans I gave out this year on Reddit, 43 paid me back and 13 defaulted. This gave me a 76% success rate and resulted in a 3% profit after six months. In other words, the open Reddit environment was more flexible and faster, but more risky and ultimately less profitable. Using goPeer was slower, predictable, and offered steady returns. In the end, in terms of financial success, goPeer should provide a little over double the profit over the span of a year.
Granted, that is a result of me investing conservatively on goPeer. Had I jumped into the higher risk categories (or taken a wide mix of low-risk and high-risk loans), the results probably would have been more variable, less predictable, more in line with what I experienced on Reddit. But I like the contrast. I’ve come to think of goPeer as more of a steady investment platform and Reddit as a fun, unpredictable bazaar.
Conclusions
While both approaches to peer-to-peer lending have their interesting aspects, the open market, forum-based approach often felt too wild and unpredictable for me. It’s entirely free flowing, which means it’s full of good people, broke people, scammers, and opportunities. It’s a free for all, which is exciting and interesting, and unregulated (for better or worse).
By contrast, goPeer is regulated, relatively calm, comparatively stable. It’s not a guaranteed way to have a profitable experience, but it’s curated. The information is gathered for us, loans can be broken into hundreds of smaller pieces to spread around both the risk and the profit, and everything is tracked for us automatically. It’s a much more clean and predictable approach and one where I don’t get regular spam messages from people and bots trying to scam me. The rate of return on individual loans is smaller, but the repayment rate is quite a bit higher (at least for conservative loans) resulting in an overall higher profit.
In short, dedicated marketplaces like goPeer are less work, result in more money, and feature fewer scams (on both sides of the experience). They aren’t perfect, they’re streamlined a bit, but it is a cleaner, calmer, nicer experience that (in my case at least) resulted in more money in my pocket.
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