Keys to Successfully Building a Portfolio of Person to Person Loans
- Make a Lot of Small Loans – Diversify Your Risk Away
The biggest danger in approving loans through a direct model is that you may not get paid back in the event the person is a fraud, loses their business, or is simply irresponsible. Thanks to the new Internet model, however, a person with only $5,000 to invest could actually make fifty loans of $100 each, in essence, acting like a bank by reducing risk through diversification. There is a very good chance that some of the borrowers won’t pay their loan back either in whole or part; in the aggregate, however, a diversified portfolio of well-chosen, credit-worthy borrowers should still return a higher rate of return than a dormant checking or savings account.
- Focus on Those with High Credit Ratings
The better a person’s credit, the lower the rate of interest you are going to earn on the money you lend them. However, Benjamin Graham taught us that an intelligent investor never accepts an acknowledged risk of wipeout in exchange for a few extra percentage points of income. Over time, the higher the credit of your borrowers, the more likely you are to experience profitability in your operation. That’s why banks focus so intently on your debt to equity ratio and income prospects.
- Utilize Standing Orders
Prosper offers something called a standing order. By creating a standing order, you can tell the system to automatically approve loans in set amounts that meet predetermined criteria such as rate of interest earned, total amount requested, debt to equity ratio, and credit rating of the borrowing. This saves you from the hassle of examining and approving loans individually and instead lets the computer system make the decision based on your specifications.
- Connect With and Utilize a Lending Group
Groups are communities of people with similar goals, objectives, and beliefs. For example, there may be a group dedicated to making and listing loans for Wal-Mart associates, or another for Southern Baptists. This allows you to connect with people who share your same political and financial agendas, particularly if you are interested in investing in your respective community, faith, or demographic. Over time, your association with a group can also lower your borrowing costs because it increases your credibility within the online community.
A Paradigm Shift?
With the hope of making higher than
average returns and the psychological joy of being able to lend money to people with whom you share a connection and have personally reviewed, is this the new face of fixed income investing? Certainly, the corporate bond is always going to have a place in society, but traditional banks just may have a run for their money if companies such as Prosper.com are successful and manage to harness the massive financial power of every day individuals.
