New member here but in the finance industry so I'd like to share some knowledge...
Myths
I can reduce my risk by lending only $25 at a time
- Yes and no. There's 2 types of risks we're dealing with, Portfolio Risk and Default Risk.
Portfolio risk is the risk that you are diversified too little. Holding 100% of one stock or one loan? You've got a portfolio risk. If that stock or loan crashes, you're done. Holding the S&P 500 ETF or 100 loans? You're diversified... low portfolio risk. Now the entire portfolio has to crash to wipe you out.
Default Risk (also called Credit Risk) is the risk that any particular borrower will default. Default risk is not reduced by reducing your portfolio risk.
Here's where people go wrong. They say, make a bunch of $25 loans and they'll be diversified from risk. Hey if they default, I'll only lose $25. Nope. You're reduced the risk that one sidewalker can tank your portfolio. If you have a diversified portfolio of high risk sidewalkers, you have high risk. The guy doesn't care that you only lent $25. If you lent $25 to 1000 sidewalkers who can't manage money instead of $25,000 to 1 sidewalker who can't manage money, you'll have 1000 $25 defaults instead of 1 $25000 default.
Take this example. Buy 100% of Treasury bills. You have theoretical high portfolio risk - if T-bills crash you're wiped out. But the default risk is as close to zero as any investment, in fact, it's treated as zero risk so the portfolio risk is very low.
Here's a simplified Formula: Default Risk x Diversification = Total Risk
---------------------------------BEGIN RANT-------------------
Your Typical Prosper/Lending Tree Borrower
TLDR; Your typical Prosper/Lending Tree Borrower is going to be a sidewalker who can't manage their money, who is drowning in debt, and is throwing a hail mary for money.
Expanded Version:
Who borrows from these companies? Do you know anyone personally?
I'll tell you who borrows. The sidewalker who's maxed out their credit cards and all available credit. It's not the responsible slowlaner cutting back or the fastlaner trying to grow their business. These companies are 4th tier lenders and target borrowers with poor credit, high utilization, high risk.
The very first place all people go to borrow money is credit cards. Slowlaners and fastlaners are usually responsible and will turn to lines of credit, home equity lines, personal loans at a bank, for access to credit. Not Prosper or Lendingtree.
Debt Consolidation? That's code speak for "my credit cards are maxed out and even Capital One won't lend me more money to finance my lifestyle". Do you really think after they pay off their cards with your money that they'll start being financially responsible? After you bailed them out?
Business Opportunity? Congrats, your money is going to that guru who's gonna make them rich so they can pay you back.
Medical bills? Most medical companies will do reasonable payment plans at reasonable interest rates. They're drowning in medical bills and you're their savior.
The dirty little secret is that A+ borrowers are really D borrowers and the rest are F. The people here, including me, that have lent money > 2 years ago knows that the defaults will come, and with every default email you'll get to a point where you'll be happy just to get some of your principal back. Forget making a return...
Think of it... credit cards lend to these same people at 20-30% interest for unsecured debt. Actually they're cut off now. What business do you have lending at 6%? Are you crazy? Credit cards write off billions of debt a year, and they know what they're doing. You're absolutely crazy lending money unsecured at less than 30% interest.
How to get 8-10% returns WITH COLLATERAL (aka security)
Now let me ask you a question. If you could get 8-10%, yes MORE than P2P, lending to a real estate investor who's going to fix & flip a house and pay you back in 6-12 months, with interest, does that sound more or less risky? If you partner with a professional, called a hard money lender (they're actually a broker matching capital with investors, doing all the active work and making a transaction fee), they should underwrite the loan and reduce your risk to very low. If the investor bombs, at least you can sell the house and recoup your money... you should never take a complete loss, and often can get all your money back. If done right, the property will be worth 20-30% more than your investment.
Second, in this situation, the borrower is not financing their lifestyle, they're trying to make $20-30k flipping a house. Their greed to make a 5 figure pay day is going to ensure you get your 10% return. There's a ton of these hard money lenders out there... just go to your local real estate investment club. The top question people will ask in every meeting is "how can I get money to finance my deal" and usually the hard money guys will stand up and pass out cards.
Now with any investment don't put all your eggs in one basket and make sure you qualify the hard money lender/broker. Talk to his other clients, talk to his borrowers, usually the ones that have been around since pre-2008 know their stuff and have a reputation for issuing good deals.
Oh and don't think you're going to just lend money to an investor directly without going through a professional broker or getting years of experience because you're going to lose it all. Underwriting (qualifying) the borrower and the deal is the most important thing. With property underwriting, your collateral is your safety net and your investor has a good verified track record...you can't go wrong.
Hope that helps... hate to see anybody make good money following fastlane principals and blow 6 figures in the P2P shell game.
Myths
I can reduce my risk by lending only $25 at a time
- Yes and no. There's 2 types of risks we're dealing with, Portfolio Risk and Default Risk.
Portfolio risk is the risk that you are diversified too little. Holding 100% of one stock or one loan? You've got a portfolio risk. If that stock or loan crashes, you're done. Holding the S&P 500 ETF or 100 loans? You're diversified... low portfolio risk. Now the entire portfolio has to crash to wipe you out.
Default Risk (also called Credit Risk) is the risk that any particular borrower will default. Default risk is not reduced by reducing your portfolio risk.
Here's where people go wrong. They say, make a bunch of $25 loans and they'll be diversified from risk. Hey if they default, I'll only lose $25. Nope. You're reduced the risk that one sidewalker can tank your portfolio. If you have a diversified portfolio of high risk sidewalkers, you have high risk. The guy doesn't care that you only lent $25. If you lent $25 to 1000 sidewalkers who can't manage money instead of $25,000 to 1 sidewalker who can't manage money, you'll have 1000 $25 defaults instead of 1 $25000 default.
Take this example. Buy 100% of Treasury bills. You have theoretical high portfolio risk - if T-bills crash you're wiped out. But the default risk is as close to zero as any investment, in fact, it's treated as zero risk so the portfolio risk is very low.
Here's a simplified Formula: Default Risk x Diversification = Total Risk
---------------------------------BEGIN RANT-------------------
Your Typical Prosper/Lending Tree Borrower
TLDR; Your typical Prosper/Lending Tree Borrower is going to be a sidewalker who can't manage their money, who is drowning in debt, and is throwing a hail mary for money.
Expanded Version:
Who borrows from these companies? Do you know anyone personally?
I'll tell you who borrows. The sidewalker who's maxed out their credit cards and all available credit. It's not the responsible slowlaner cutting back or the fastlaner trying to grow their business. These companies are 4th tier lenders and target borrowers with poor credit, high utilization, high risk.
The very first place all people go to borrow money is credit cards. Slowlaners and fastlaners are usually responsible and will turn to lines of credit, home equity lines, personal loans at a bank, for access to credit. Not Prosper or Lendingtree.
Debt Consolidation? That's code speak for "my credit cards are maxed out and even Capital One won't lend me more money to finance my lifestyle". Do you really think after they pay off their cards with your money that they'll start being financially responsible? After you bailed them out?
Business Opportunity? Congrats, your money is going to that guru who's gonna make them rich so they can pay you back.
Medical bills? Most medical companies will do reasonable payment plans at reasonable interest rates. They're drowning in medical bills and you're their savior.
The dirty little secret is that A+ borrowers are really D borrowers and the rest are F. The people here, including me, that have lent money > 2 years ago knows that the defaults will come, and with every default email you'll get to a point where you'll be happy just to get some of your principal back. Forget making a return...
Think of it... credit cards lend to these same people at 20-30% interest for unsecured debt. Actually they're cut off now. What business do you have lending at 6%? Are you crazy? Credit cards write off billions of debt a year, and they know what they're doing. You're absolutely crazy lending money unsecured at less than 30% interest.
How to get 8-10% returns WITH COLLATERAL (aka security)
Now let me ask you a question. If you could get 8-10%, yes MORE than P2P, lending to a real estate investor who's going to fix & flip a house and pay you back in 6-12 months, with interest, does that sound more or less risky? If you partner with a professional, called a hard money lender (they're actually a broker matching capital with investors, doing all the active work and making a transaction fee), they should underwrite the loan and reduce your risk to very low. If the investor bombs, at least you can sell the house and recoup your money... you should never take a complete loss, and often can get all your money back. If done right, the property will be worth 20-30% more than your investment.
Second, in this situation, the borrower is not financing their lifestyle, they're trying to make $20-30k flipping a house. Their greed to make a 5 figure pay day is going to ensure you get your 10% return. There's a ton of these hard money lenders out there... just go to your local real estate investment club. The top question people will ask in every meeting is "how can I get money to finance my deal" and usually the hard money guys will stand up and pass out cards.
Now with any investment don't put all your eggs in one basket and make sure you qualify the hard money lender/broker. Talk to his other clients, talk to his borrowers, usually the ones that have been around since pre-2008 know their stuff and have a reputation for issuing good deals.
Oh and don't think you're going to just lend money to an investor directly without going through a professional broker or getting years of experience because you're going to lose it all. Underwriting (qualifying) the borrower and the deal is the most important thing. With property underwriting, your collateral is your safety net and your investor has a good verified track record...you can't go wrong.
Hope that helps... hate to see anybody make good money following fastlane principals and blow 6 figures in the P2P shell game.
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