One of the biggest issues any new lender will face is how to gauge what his or her true return on investment is. It is somewhat misleading to bid on a loan with a high interest rate attached because there are so many additional factors that come into play later on that will reduce your overall return.

For example, how many of these loans have historically defaulted? Generally, the higher the credit grade, the higher the return. However, when creating a portfolio plan in Prosper, you can easily score a higher return with a lower credit grade by adjusting constraints such as the debt to income ratio, loan amount, now delinquent, delinquencies in the last seven years, annual income, employment status, etc.

One of the many new features with the customizable portfolio plan creator is a neat little section off to the right when you add a “slice” to your plan. For starters, it will allow you to place the minimum bid rate you are willing to achieve on any particular loan.

Okay, so this isn’t anything new — we’ve seen this before using Prosper’s old standing order function. What is important is the fact that Prosper has been around long enough that they now have a realistic grasp as to what the loss on ROI will be given historic loans made that fit your specific criteria. It takes many months and loan samples before realistic returns can be projected.

With this data, Prosper can now calculate the following:

–Estimated loss due to default
–Adjustments likely to be made over the course of the loan
–Reduce return on investment for servicing fees.

Then, once you have your lending criteria defined, you can click on the “calculate” link to find out what your estimated return will be. (See chart below)

Now, lenders can go back and mess around with numbers and constraints to see how the returns will adjust. For example, I tend to see the estimated return rise significantly if the borrower has no delinquencies, is employed for at least two years, and has a debt to income ratio below 50%. Of course there are other important factors that will increase your projected return. I have enclosed my own personal lending criteria as a guide to get you started.

If by chance you tweak the constraints to allow for a higher return without adjusting the minimum bid rate, please let me and the rest of the Jutia Group readers know, we’re all in this to make money together and perhaps you found something I overlooked!

Personally, I will only lend to borrowers with credit grades of AA, A, and B. I’ve had some poor results with those who tend to fall closer to the subprime borrowing mark.

Overall, lenders now have the ability to chart a path toward realistic returns. No longer can lenders expect to lend to someone who is willing to pay 20%+ interest and expect that in general they will honor their obligations and pay them in a consistent manner. Defaults can really kill your return. With the calculator tool, discussed above, we now have the knowledge and ability to make better lending decisions.

Wishing you many profitable loans,
Stephen Oakes