There's been a lot of hype about a newish Web site called Prosper.com that facilitates peer-to-peer lending. In short, you can go to the site and either try to secure a loan from other people that visit the site, or you can go to the site and be a lender, loaning out your money to others who need it.
Salon did a feature on it, as did BusinessWeek earlier this year (under the headline "The eBay of Loans?"), and I saw another one a few days ago. The site is run partly by the co-founder of E-Loan, Chris Larsen, so it's got some credibility in management. One person has already dedicated a whole blog to the wonders of Prosper.
It's really an exciting idea. Unfortunately, it will fail.
1. Scammers – The Internet provides excellent anonymity. While Prosper does do credit checks of those seeking loans and puts a credit rating for them right on the site, that doesn't stop those looking for money from creating elaborate scenarios as to why their credit is so bad (job loss, hospital bills, etc.) and why you should take a chance on lending to them. Sure, some people get into money trouble because of job loss and unexpected hospital bills, but others get into money trouble because they gamble, drink, or just plain like to shop and are happy to find a sucker who will feed the habit.
And you know there are already teen hackers in the Ukraine who are looking for ways to use the identities they stole this morning to nab some money from gullible Americans.
Be softhearted and you could see your money go bye-bye.
2. People with good credit don't need it, people with bad credit have nothing to lose. Look on Prosper and you will see that many of these loans are going for interest rates of 15% and more. The only people getting decent rates are those who have good credit, and there aren't nearly as many of them.
Why? Because people with good credit can get comparable or cheaper rates with a credit card, home equity loan, or small business loan if need be. They don't need this service, although a few may try it out to see what they can get.
If you have bad credit, however, why not use Prosper? You've got nothing to lose, because your credit's already shot and you might be able to get some money at a better rate than the payday loan lender is giving.
If you're a lender on Prosper, the promise of loaning your money out at 17% sounds great, until the loans start defaulting. Prosper's in its honeymoon period now, but when those high-interest loans come due, you'll see why the lendees have the credit ratings they do.
Which brings me to my next point:
3. Lenders will leave after getting burned or getting bored. Because the number of decent credit customers will be low, Prosper lenders will either tire of the site because their only potential lendees have horrible credit, or they will start making riskier loans in search of higher returns, and will leave after getting burned one too many times.
It's very tempting to lend at the rates you see on Prosper, especially when the stock market's unstable. But whole companies, made up of smart people with financial expertise, have been set up to offer loans to bad credit customers, and many of those companies have folded after too many defaults.
Anyone remember NextCard, the Internet credit card of a few years back? They offered easy credit and the government had to shut them down when they lost millions and millions of dollars. Other credit card companies serving the "subprime" customer have seen humongous losses, especially in economic downturns.
Maybe Prosper's lenders are smarter than these companies and will loan to only the right people. But how likely does it seem that a nation of lenders doling out money from their computers are going to have the expertise to outwit banks and other lending institutions?
Lenders who stick around are going to get burned and the downward spiral will be inevitable.
4. It's not an eBay of loans. BusinessWeek used the "eBay of loans?" headline to give a quick take on what Prosper could be. But where eBay uses its feedback feature to keep people honest (although of course not everyone is), Prosper can't really do the same. Many people on eBay are repeat customers–they want to play fair so they can keep playing. The only people likely to be repeat customers of Prosper are going to be those with financial trouble. Really, how many times do most of us need a $1000 loan if we have control of our finances?
So there is no real incentive to pay these Prosper loans back, especially if your credit record is already in shambles, because you don't need to worry about how you'll look to Prosper lenders later on.
Am I being too hard on Prosper? Am I looking only for the negatives and hiding the positives, glossing over the many safeguards Prosper has put in place to make this loan marketplace work? Am I just jealous that I didn't think of it first? Maybe.
So tomorrow I'll tell you why Prosper.com will succeed. [UPDATE: That article is now available here.]
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