P2P Loans enable individuals to lend and borrow money directly from each other. The loans are unsecured, meaning there are no assets like a car or a house that lenders can claim if the borrower defaults. For this reason, the loans tend be small (under $35,000) and the interest rates which borrowers pay high.
In the United States, there are two primary peer to peer lending sites which enable investors to purchase P2P loans, Lending Club and Prosper. Prosper was the first major industry participant and Lending Club is currently the largest, facilitating around $60M in new P2P loans per month.
Both companies assess the credit risk of the borrower and assign a credit rating. The interest rate which the borrower is charged is primarily based on the credit rating and length of the loan (1,3, and 5 year loans are available). The return on investment of the loan is based on the interest rate charged to borrower minus the fees for servicing the loan (1% per year) and the losses from the non-payment of interest and principal.
The chart below shows the loan rating on the X-axis. The first rating listed is from Prosper and the second is for Lending Club. The y-axis shows the interest rate charged to the borrower and the return on investment to the lender investment for a 3 year loan. The peer to peer loan returns on investment is taken from LendStats, a third party site which has a uniform methodology to calculate returns. Returns are for loans made between 2010 and July 2012.
While there are large differences in interest rates between loan grades, the return on investment between different rating is between 5.1% and 9.2% Also, the returns between Prosper and Lending Club are very similar.
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