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The Benefits of Peer to Peer Lending – Whiteboard #2

Peer to peer lending is a great opportunity for those who are interested in alternative approaches to investing, allowing us to take control of our portfolio and earn lucrative, consistent, socially-responsible returns through targeted diversified approaches.

Video Transcription

Now in the last video we kind of covered the overall mechanism of peer to peer lending, that is, how this is allowing borrowers and lenders to meet each other on a large scale over the internet. And today we’re going to look at the benefits to this whole thing, meaning, why investors are getting involved in this in the first place.

Peer to peer lending is kind of brand new. See, Prosper did not even come out until 2006, and Lending Club did not launch until a year later in 2007. So there isn’t a ton of consensus as to why peer to peer lending is a great thing. That said, I think we can kind of hone in on four great reasons today, so let’s do that.

Benefit #1: Peer to Peer Lending’s Solid Returns

Now, the main reasons that people are interested in any investment has to do with the returns that it offers, and peer to peer lending offers us great returns. As we talked about in the last video, the average interest rate that we offer borrowers on loans at Lending Club would be something like 13%. And considering 3-4% of that is going to be lost to defaults, people just taking our money and ditching us, and another percent is going to be lost to platforms fees, that means that a net annual return for us can be something like 8%, which is really great in this environment. The average savings rate is something like 0.6% or something like that? So an 8% return is really awesome.

Lending Club actually released a large amount of data recently that showed the return that investors are earning, particularly those that have seasoned accounts that had been with them for some time. And all these investors, like 90-some percent of them were earning between a 5-10% return.  And when LendingMemo actually surveyed a bunch of experts recently, we had the exact same response. We asked them, “What is the return that we can expect in this investment class?” And they all said between 5-10 or 5-11 percent.

Benefit #2: P2P Lending’s Consistency

Now on top of great returns, peer to peer lending is also a really consistent investment, and that is because we’re not just investing in companies that can kind of rise and fall. We are investing in people, particularly people with really great credit – prime borrowers, or as the nomenclature of the industry says, prime consumer credit – lines of credit.

What does this prime consumer credit offer us? What do these borrowers with really great credit give us? That is the ability to have a really consistent return on investment over time. So for instance, in 2008 what was categorized by many as the largest financial catastrophe since the great depression, Lending Club still returned 3%. I don’t know if many of you know this, but on that same year the S&P 500 (which is kind of a general picture of the stock market for many) returned a -35%. A third of people’s investment got lost if they had it in the S&P.

So compared to the stock market, peer to peer lending is much more stable and consistent return over time, and you can see that in the steady default rates ever since 2008, so 2009, 2010, 2011, 2012, these have really consistent default rates over time, meaning we are tracking how these borrowers are paying back their loans month by month, and for every single year they are kind of tracking along the same trajectory. Prime borrowers give us a really consistent and very lucrative return.

Benefit #3: Control Within P2P Lending

Now, that said, peer to peer lending offers some really interesting kind of side benefits that something like a mutual fund would never offer, and that is control. Peer to peer lending offers us to really get deep within our own investment. Well, we can choose to. If we want to have a hands-off, generalized investment into peer to peer lending, we can. But, if we want, we can really start to target where our money goes, and that is because all the historical data is made public. If you want to go on Lending Club or Prosper’s website right now, you can download a spreadsheet of all the loans they have ever issued in their company’s history. And what does that mean for us? You can take this spreadsheet, open it up in Microsoft Excel, and analyze what patterns have existed in the company’s past. You can look at it and say, “Boy, certain groups of borrowers pay their loans back more consistently than other groups.” So, not to pick on those of you who have a small business, but small business loans over these platforms have a statistically lower rate of return than everybody else. Now, it’s not a ton, but it is a little bit. So maybe if you wanted to, you would just never invest in small business loans, ever. If you wanted to do that, you could say “I will never put a dollar in a small business loan,” and you could make that decision.

So all of this historical data allows to really target our investment. We can say, “I want to put all my money over here,” or “I want to put a little bit over here but the main amount over here.” We can really have a lot of control over our investment. Now regarding that historical data, just because it’s there doesn’t mean we have to target specific borrowers. We can also invest in the platform averages. Like we said over in this side of things. The generalized return is still pretty great: 8%. But if we want to, we can target these specific borrowers and actually push that a little bit higher, something around 9 or even 10 or 11 percent.

Benefit #4: Liquidity in P2P Lending

The other thing that peer to peer lending offers is the ability for us to liquidate our portfolio over time. See, and this is going to be a little bit of terminology being thrown at you, but peer to peer loans are classified by the SEC as securities, so they can be bought and sold. If you wanted to, you could liquidate your entire investment at any time on a secondary market called Foliofn. Now, this isn’t necessarily available to IRAs, but regular accounts, you can do that at any time. So there is a ton of liquidity, which is a lot better than (some people consider) the stock market. If you buy a stock and it tanks, you may have to wait years for that stock to recover. But let’s say you had a Lending Club or Prosper taxable account, and you just don’t feel it anymore and you want to pull your money out, you could just liquidate the whole thing on the secondary market, and you could have your money back to you without much of a drop or maybe even a premium that you could get for those. I mean, let’s say you had a bunch of loans with steady repayment history, those are actually worth more now than when you first got them. So you could actually make money through liquidating your account. It’s pretty great.

Benefit #5: Social Responsibility

Finally, I want to touch on social responsibility. Peer to peer lending is good for society for two main reasons. For one, for the way it cuts out the banking system, and two, for the way it gets people out of debt.

P2P Lending Cuts Out the Banking System

See, Lending Club and Prosper are companies that are actually based on these server farms. They don’t have tellers or vaults like banks do. They do not have to hold a bunch of cash. They’re not FDIC insured, but that said, they are incredibly nimble. What does that mean for us? That means lower rates on loans than have ever been offered before. So if somebody with great credit, like an 800 credit score, would go and apply for a credit card, they would be offered the same credit card rate as just anybody else. Yet, if they would go and try to get a peer to peer loan, because Lending Club and Prosper operate at such a low cost, they can offer these people a rate of something like 6% for an unsecured loan, which is historically low. That opportunity has never been there before.

So these banks are basically being cut out. And for those of you who are like me, who feel like banks kind of have a little too much sway in our country, and are large inefficient symbols of where our country used to be, and not necessarily of where we want to go, then maybe peer to peer lending is an investment you should consider.

P2P Lending Gets People Out of Debt

Finally, we need to remember that peer to peer lending gets people out of debt. 80% of these loans are going to be offered to people who are consolidating debt. Those large percentage credit cards that people are struggling under the weight of, those people with five different bills to five different banks that have five different credit cards, they can consolidate that under one easy rate, so that’s where the majority of our investment is going. So we can feel good about this investment, not just for the great return it offers, or for the consistency, or for the control that we have over our investment, but for how this is getting people out of debt – a good thing, something our country needs.

Conclusion

And those are kind of the four big reasons why peer to peer lending is a good thing: for the return it offers, for the consistency of this investment, for the control that it gives us as investors for us to really target where we want to put our money, and for the social responsibility, for how peer to peer lending is a good thing that our country really needs.

So, I hope you can kind of see a big picture for why this is such a great investment. The question is, what are the risks involved in peer to peer lending. I mean, earning an 8 percent return, there’s no way you could get that kind of return without there being some sort of risks present. And you would be right. The truth is, some people have lost money in peer to peer lending. There are risks involved with this whole investment. The question is, what are those risks?, and the answer will be the subject of our next video.

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