Problems with P2P Loans

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 lender, you 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 gained.

Prosper was developed prior to the times of the 'model risk' calculation back when lenders and financial institutions relied on FICO 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 P2P loan 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 Prosper’s 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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