PROBLEM WITH P2P LOANS
One of the first companies to hit the person-to-person lending space was
Prosper. Many banking experts feel that their launch was very poorly timed.
Prosper opened its lending doors right at the peak of credit boom. Therefore if
you were one that was a Prosper
probably lost money since many of the loans back then were defaulted. In fact,
Prosper has reported that more investors lost money during these times than
Prosper was developed prior to
the times of the 'model risk' calculation back when lenders and
financial institutions relied on
scores and computer algorithms in determining credit risks.
The problems Prosper faced (the credit crunch and the consequent
recession), can easily be considered a one-time occurrence with
a minimal chance of repeating. However an additional is
prevalent to the archetype: consumers that are looking to become
borrowers with Prosper with a certain FICO score are predictably
more likely to default on their debts than the majority of other
people with the identical credit score.
That's not the way Prosper intended. The
platform was intended to develop a personable association
between lender and borrower, and hopefully result in borrowers
more probable in repaying their debts than those confronted with
huge commitments to loathed, anonymous banks. However it appears
that contrary selection impacts besieged the Prosperís goal of
being fuzzy and warm.
The situation is that contrary selection problems are
undefeatable. People apply for a person-to-person loan as a
result of not being able to obtain cash through the normal
channels of financing (banks, credit unions, etc.) and there is
always a reason why. Prosper has reported that the worst clients
end up being those with decent credit that are willing to pay
extremely high interest. They are willing to do so as a result
of their financial situation being much more damaged then their
credit score is reporting.
Also, when you set-up a store or website and encourage
applicants to come to you, you are inviting a very dangerous
type of borrower. This is why the credit card companies send out
preapprovals to people as opposed to doing heavy online
marketing in attempts to get people to visit their websites.
They prefer to make offers to people than to have blind
applications coming in. The ultimate irony of lending is that
the consumers that are more probably to repay their loans are
those that really are not in full need of the money. And
unfortunately, P2P lenders are attracting people that do need it
since they can not get approved at their banks.
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