Adventures in Peer-to-Peer Lending

The peer-to-peer lending industry is having some major problems. Since I used to actively invest in peer-to-peer (P2P) loans, I'd like to share some of my experience and why I got really far away as fast as possible a few years ago.

Peer-to-peer (P2P) lending is where a company sets up a website and invites people on who either a) need to borrow money or b) have money to lend. The borrowers go through a vetting process of some sort, including a credit check, perhaps income verification, and perhaps other checks depending on the company. They state why they want the loan and how much and the term. Then the company lists their loan request on its website and invites lenders to browse all the available loan requests and pledge money to whichever ones they want to fund.

The lender - me - can offer as little as $25 or as much as the whole requested amount. Thus, if a borrower requests a loan of $25,000, it can be fulfilled by 1,000 lenders contributing $25 apiece, or a smaller number of lenders pledging a larger amount on average. The company that coordinates this takes a cut, the lenders get to diversify their investments across tons of borrowers, and ideally since the company's take is so much smaller than the bank that would normally provide the loan, everyone comes out ahead.

I found this pretty attractive and pitched in a few thousand dollars back in 2010 or 2011 with a company called LendingClub.

The most compelling aspect of this system for me was that as a lender, I got to converse directly with the borrowers. I skipped all the wedding loans, vacation loans, and others where the loan wouldn't generate any income, and focused on the loans for refinancing credit cards or other bank debt. Replacing a 20% loan with an 8% loan is free money, assuming the borrower has a plan in place (and the emotional strength) to stop being debt-dependent by reducing expenses, getting a new job, or something else.

I would browse the list of refi loan applications and ask each borrower a standard set of questions that I hoped would help me do the following:

1. ensure the borrower plans to use the loan for the stated purpose, not as a scam
2. ensure the borrower will actually change whatever aspects of their lives got them into this debt so that
3. the loan results in net debt reduction, not net increase

If all those held, I felt comfortable investing. And so I got pretty particular with my questions. I don't have the list I used to use, but it was something like this:

1. Please list all the credit cards, their interest rates and balances, as well as all other loans, their rates, terms, and balances.
2. Please share your monthly budget, including all income and expenses. Describe how you're changing your budget in order to reduce debt dependence.
3. Do you have a spouse? If so, how do you coordinate your budgeting with them?
4. Please describe what lessons you've learned from getting into this debt and how you'll avoid relapsing into debt in the future

Believe it or not, I actually ended up having conversations with borrower applicants where they'd present all this information! They'd share conversations they'd had with their spouses on the forum, or budget problems they faced, or whatever. Quite often, they'd also show they had no budget and no concept of how to budget. A few times I tried to help teach the borrower what a proper budget looks like but I quickly learned it wasn't worth my time and just decided not to invest in those loans. I know a person could lie to me about all this and there'd be no way for me to find out, but I figured a real conversation with lots of faked budget and loan information would be more work than a scammer would bother with, so if I got a good feeling from the conversation on the forum, I usually pitched in $25 or occasionally $50.

On top of this, I got to see all the questions posed by other lenders and the borrowers responses, so between my conversation and the others, I often felt like I could make a decent enough decision - especially given that I was only talking about $25 or $50.

I can't really know how badly I got scammed, but I can say that after 5 years my yearly return is 9.3%, so I didn't do too badly. I got to diversify over a few hundred loans by contributing $25-$75 per loan, and it was fun sometimes chatting with borrowers and getting to know people's situations.

I never invested much with LendingClub, but I found it fun and interesting, and I felt like I could protect meself from being fleeced. I expected to invest more and more as I got more comfortable with the system and saw that it worked as advertised, hopefully making it a significant investment someday.

But sadly, this was not to be.

From my perspective, the downhill trend started when Lending Club forbade the conversations I had. I could no longer ask free-form questions.  If I wanted, I could select pre-set questions to submit to the borrower, who could respond or not. I couldn't follow up to the borrower's response either, so we couldn't have a conversation. If s/he responded, that was it - I couldn't challenge the response or bring follow up questions! No conversation, nada.

After Lending Club's changes, I noticed other new problems. I began to notice that people were requesting loans of $25k or $35k without answering ANY questions from lenders. The loan application would be practically empty, with just a credit score, loan amount, and a few other data points, but unverified income, unverified job, and not so much as a paragraph about the loan purpose, the borrower's life situation, or anything else. Within a few days, enough lenders had pledged enough money to meet the whole $25k or $35k loan request!

A few times I tried to submit the pre-set questions, but the loan would get fulfilled before the borrower answered my questions. Talk about frustrating - how on earth am I supposed to protect meself from getting fleeced? It's like the other lenders' standards just fell through the floor, and I could either loan money with no insight at all about the borrower, or I could not loan money at all.

On a different note, I was learning more and more about the financial fraud which had occurred in the years leading up to the '08 crash and how it was (mis)handled afterwards by the government. I saw that the rich were able to protect themselves at the expense of the poor, how we're seeing a massive increase in inequality as the rich take all income gains, how infrastructure and other public goods are losing value all the time - the list goes on (and perhaps I'll describe this learning process in a post soon), but the pattern is that the poor and middle-tier folk ain't doing so well, and that was just the group I was lending money to! Lending Club bragged about how great the ROI was for lending on their platform, but they pretty much started after the '08 crash, so I couldn't trust that the returns I'd expected (7-10%) would hold up across the next major downturn.

So back in 2012 or 2013, I stopped transferring money into Lending Club and started transferring money out, hoping that the outstanding loans would wrap up before the next crash. I just took out another $150 or so, and with ~$350 left in outstanding loans, I'll soon be all done.

Of course, I'm now less interested in accumulating dollars and more interested in other pursuits, but it's interesting to reflect on my own personal experience in a credit cycle and watch the lending standards plummet just like I read happened in the housing market in the lead up to the '08 crash. When I tell people that bankers sometimes knowingly make bad loans, they give me a look like I'm crazy. If only it weren't so!