I’ve been “lurking” for a while and I finally joined to see if some of the smart people here could answer a question for me. I was telling some one I had some money and that I was going to invest somewhere, and she told me I should look into prosper.com.

It looks like its real, but I don’t know. People post on there asking for loans at a certain interest rate, and if you want, you can offer to lend them money. They’re supposed pay you back, and the interest you charge them is higher than you’d get from the stock market or something.

Is this a scam? Is it a good investment?

It’s real. Whether or not it’s a good investment is a different story.

It bills itself as peer-to-peer banking. I’ll let someone who read the legal fine print to explain whether or not it actually counts as banking according to the appropriate regulations. The site (through Experian, a credit bureau) runs credit checks on all applicants and publishes a confidence score on them. This confidence score is what their internal model believes the probability of the borrower repaying their loan is. If the borrower defaults, Prosper will arrange to have the account transferred to collections - I’m not sure if they buy out your loan or not, and at what price if they do.

The quality of the investment you make depends entirely on the risk you undertake. Lending to AA/A-level borrowers is pretty safe, and unsurprisingly does not yield much in interest. Lending to D/E-level borrowers, on the other hand, is not safe at all, and yields high interest rates.

Assuming everything is on the up-and-up, one complaint I’ve heard about Prosper is that since you (as a lender) are not a ‘real’ bank, you cannot do fractional reserve banking. You don’t have people depositing money in savings accounts with you, which you can then lend out. You aren’t a customer of a Federal Reserve bank, so you can’t take out loans at prime rates, which you’d then re-loan at subprime rates. So this isn’t as much banking as buying bonds. In many cases, junk bonds. Small junk bonds.

We did a thread on this a couple weeks ago. Here it is.

I decided to test it out by investing a few hundred bucks and so far I’ve bid on several loans, ranging from good credit/low interest to mediocre credit/high interest. In a few months we’ll see how well they do.

The idea is pretty simple. Someone posts a request for a loan and the maximum interest they’re willing to pay, lenders get to see their credit rating and information on delinquencies and so forth. Then you bid, dutch-auction style, for the amount of the loan you’re willing to fund and the minimum interest you’ll accept. Prosper then tries to assemble a winning combination of bids to fund the loan. Right now they only offer a term of three years.

The actual loan originates at Prosper, and is then sold to the lenders. So the lenders aren’t really lenders, they are just people buying debt securities.

Every month, Prosper attempts to do a direct withdrawal on the borrower’s bank account for the installment, takes a small cut, and distributes the rest to the “lenders.”

If the payments go into default, Prosper gives the loan to a collection agency, and the lender gets a fraction of whatever they recover, equal to their relative investment in that loan.

In a few months I think I’ll post a detailed thread about how much I make (if anything) and how good an investment I think it is. It certainly is a fascinating experiment.

There’s also a Prosper message board at http://prosper.spreebb.com/