How to Evaluate The Risks When Investing In Peer to Peer Loans
Through the services offered by Prosper.com and The Lending Club, investing in unsecured loans can be a viable investment alternative. But unsecured loans are risky. By using Prosper investing and The Lending Club you can minimize some of the risks usually associated with this sort of investment opportunity. Investors ultimately become responsible for choosing the level of risk they wish to undertake.
The bank that manages Prosper and The Lending Club's loans will pursue any defaults on the loans. Despite this, there is still no guarantee that any funds will be recovered. It is the investor's responsibility to make sure that any defaults on payments to their loan are not going to have disastrous consequences.
Bad loans can be partially avoided by carefully examining the borrowers who are applying for the loans. For the sophisticated investor with knowledge of underwriting principles, evaluation of payment history, credit score, and delinquent status is invaluable.
For everyone else, Prosper or The Lending Club issue the loan with a grade in the form of a letter. Prosper uses a scale from A to E, with high risk loans being designated with a HR. The Lending Club have a more complex system, with over 30 subgrades, A1-G5. Each grade attracts a different interest rate, ranging from 7% for lower risk loans, and high risk loans attracting a 30% rate. This begs the question of why not just invest in the high interest loans.
The reason is that the higher the return the greater the risk. Prosper investments tend to lean towards the higher risk category, whereas Lending Club investing can be slightly more conservative. This attracts more borrowers to Prosper, who have a higher chance of defaulting on the loan. Lending Club investments, as well as Prosper, charge a 1% commission fee to investors, which is not shown on the face amount of the loan. A simple calculation will show that the borrower is being charged more than what the investor is getting paid.
There are not many peer to peer loans from either Prosper or The Lending Club, that can claim to be low interest. And, for those that are genuinely low (less than 10%) there is remains the chance of a default. Diversifying the loan portfolio is without a doubt the surest way to minimize risks from defaulting borrowers.
To diversify the portfolio requires investing smaller amounts in as many loans as you can. A single loan, at even the lowest rate, can still represent significant risk. If a borrower loses his or her job, that borrower loses his or her ability to repay. Following that sort of event, the investors loses their principal investment as well as future interest payments. The fact that Prosper and the Lending Company have a minimum loan requirement of only $25.00, plus pooled loan accounts, mean it is a relatively simple matter to spread your risk over a diverse portfolio.
Any investing strategy can benefit from diversity, to not do so can have serious consequences for an investor's financial health. As little as a 15% default rate can drop the return of an investment from 25% to 7%. Projected default rates are regularly published by Prosper and the Lending Club for all grades of loans, with discounts on interest rate performance varying from 2% to 10%. Always verify these figures, and thoroughly go over the prospectus before you hand over any money.
There is no doubt that investing through The Lending Club [http://peerlendingtoday.com/] and Prosper investing [http://peerlendingtoday.com/] can lead to lucrative returns if done wisely. It is essential to be aware of the risks, this is not an investment to make with the mortgage payment money. This is especially if you are going after the higher returns. It definitely makes a lot of sense to get professional advice before making any decisions.
The bank that manages Prosper and The Lending Club's loans will pursue any defaults on the loans. Despite this, there is still no guarantee that any funds will be recovered. It is the investor's responsibility to make sure that any defaults on payments to their loan are not going to have disastrous consequences.
Bad loans can be partially avoided by carefully examining the borrowers who are applying for the loans. For the sophisticated investor with knowledge of underwriting principles, evaluation of payment history, credit score, and delinquent status is invaluable.
For everyone else, Prosper or The Lending Club issue the loan with a grade in the form of a letter. Prosper uses a scale from A to E, with high risk loans being designated with a HR. The Lending Club have a more complex system, with over 30 subgrades, A1-G5. Each grade attracts a different interest rate, ranging from 7% for lower risk loans, and high risk loans attracting a 30% rate. This begs the question of why not just invest in the high interest loans.
The reason is that the higher the return the greater the risk. Prosper investments tend to lean towards the higher risk category, whereas Lending Club investing can be slightly more conservative. This attracts more borrowers to Prosper, who have a higher chance of defaulting on the loan. Lending Club investments, as well as Prosper, charge a 1% commission fee to investors, which is not shown on the face amount of the loan. A simple calculation will show that the borrower is being charged more than what the investor is getting paid.
There are not many peer to peer loans from either Prosper or The Lending Club, that can claim to be low interest. And, for those that are genuinely low (less than 10%) there is remains the chance of a default. Diversifying the loan portfolio is without a doubt the surest way to minimize risks from defaulting borrowers.
To diversify the portfolio requires investing smaller amounts in as many loans as you can. A single loan, at even the lowest rate, can still represent significant risk. If a borrower loses his or her job, that borrower loses his or her ability to repay. Following that sort of event, the investors loses their principal investment as well as future interest payments. The fact that Prosper and the Lending Company have a minimum loan requirement of only $25.00, plus pooled loan accounts, mean it is a relatively simple matter to spread your risk over a diverse portfolio.
Any investing strategy can benefit from diversity, to not do so can have serious consequences for an investor's financial health. As little as a 15% default rate can drop the return of an investment from 25% to 7%. Projected default rates are regularly published by Prosper and the Lending Club for all grades of loans, with discounts on interest rate performance varying from 2% to 10%. Always verify these figures, and thoroughly go over the prospectus before you hand over any money.
There is no doubt that investing through The Lending Club [http://peerlendingtoday.com/] and Prosper investing [http://peerlendingtoday.com/] can lead to lucrative returns if done wisely. It is essential to be aware of the risks, this is not an investment to make with the mortgage payment money. This is especially if you are going after the higher returns. It definitely makes a lot of sense to get professional advice before making any decisions.
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