Building My Own Bank!

Posted by ben

May 16, 2008

Look at me Ma! I’m building my own bank! Whether it was selling licorice out of my high school locker, or pawning computers on Craigslist, I’ve always been an entrepreneur. But who would have ever thought now I’d be starting my own bank! Sure, for a little while I worked at America First Credit Union, a local Utah credit union. I’m not typing about that though…I mean I’m really lending out money myself. I’ve already issued 49 loans to some of the most varied customers;

consumers consolidating debt to pay down high interest credit cards;
someone purchasing a home greeting service franchise;
someone using the loan to pay his yearly Uncle Sam “live in America” franchise fee;
someone buying a Daewoo Skid Steer for his business;
etc…

The best part about it all is that my average interest rate is now at 15.57%! Why are these people paying me such high interest? How can I afford to issue all these loans? Where did I get such authority? Why do I trust someone who wants to buy a Daewoo Skid Steer? Good questions. Let me explain.

Last September my economics teacher introduced me to a new form of lending, called P2P lending, which is short for Peer to Peer, or Person to Person. This form of lending is completely operated via this new fangled device, called the “internet” (I heard Al Gore invented it…and that is how he is so rich). There are no papers needed, so I am saving a lot of trees (Al Gore really likes that too).

Business & Personal Loans. Great Rates. Prosper.

Borrowers:

People that need loans go online, to www.prosper.com and they “request” a loan. The loan can be for anything between $1,000 and $25,000. Prosper, an actual “financial institution” that is regulated just like banks and credit unions, then checks the persons credit, validates their employment, and checks whether or not the person owns a home. With that done, the person is now ready to borrow. The borrower makes their request and states the maximum interest they are willing to pay for the loan.

For example, Bill has $12,000 on three credit cards, each with interest above 19%. So, he calculates the closing rates that Prosper charges (which are much lower than traditional loans…hence Prosper has grown by leaps and bounds) and figures them into the life of his credit card debt and comes up with the interest rate of 17% being as high as he wants to pay. So, he makes a request for $12,000 at 17%. Prosper usually gives about 7 days for his request to be filled by lenders.

Lenders:

On the other end, I give Prosper my credit union routing numbers (just like you have to do for direct deposit with your employer, to use PayPal or Google Checkout, etc) and they set up an account for me. I can transfer money between my online Prosper account and my physical local credit union account (at least $50 into Prosper and any amount out of Prosper) freely, at any time I want, as long as it isn’t already loaned out to someone. I then search the Prosper site for people that are borrowing, using search queries such as borrower income, credit ratings, whether they have a home and how long they’ve been on their job. I can then read their “loan request” and decide whether or not I want to loan to them. I say yes, and give them a small portion of what they’re asking. The lenders can loan any amount above $50, and are actually encouraged by Prosper to lend between $50 and $100 a loan, to minimize risks. This means that I can loan out a lot of money without as much risk as lending it all to one person.

Going back to the Bill example, If he has good credit (700+ points) then lenders will flock to his loan request and assuming that each lender is only issuing $50 increments his 24 loan spots ($12,000/$50 increments) will fill up with lenders willing to lend at 17% pretty quick.

This is where it gets really fun! If a loan is full, but their is still time remaining from the original fulfillment time issued by Prosper (usually 7 days to fill the loan) then other lenders can come on and say they are willing to take as little as 15%, 14%, 13%, etc for a $50 share of his loan. If he has an excellent credit score (around 780+) then this type of loan would typically fall to around 10% - 12% interest before it closes. So, in other words, lenders bid for their loans!

Bill gets his $12,000 and promises to pay the loan back at 12%. An actual promissory note is generated and put in the lenders account, and if the person doesn’t pay then a collection agency goes after the borrower. He pays off his credit cards and saves a couple thousand dollars (from the lower interest rate) in the long run, so he is thrilled! The lender gets 12% interest on that $50 for the life of the loan (3 years or whenever the borrower pays it off, if earlier than 3 years). The lender is thrilled because the 12% is as high as most stock portfolios go, and he actually gets to help out a little guy!

My Prosper Successes and Struggles:

I put $250 of my own money into this about 6 months ago. I like it, the interest rates were high. I convinced Celeste to let us put some more of our family savings into it. Since then our other venue of savings, dedicated savings accounts (similar to CDs), have bottomed up with the Fed lowering the interest rate. Now we are only getting about 2.5% in our dedicated savings! My business funds in my PayPal Money Market account are only getting 2.61% too! So, it’s nice to have a direct connect to borrows like this. Instead of a bloated bank or corpulent credit card companies getting the benefits of lenders paying high interest, I do! Plus, it really does feel good to be helping small businesses get started and helping people eliminate their higher interest credit card debts.

It’s not all roses though. You need to be careful to whom you lend money. I’ve had people late on payments, and even have some defaulters right now. The typical default rate for the A and AA credit group (730+ points) is currently a little less than 2%. My defaulters are a B and C grade borrower. Typically B grade borrowers are a lot safer than C, and so my wife and I have decided we won’t be lending to C grade borrowers anymore. This means our interest will go down a point or two, but it will be worth it in the long run. Another drawback is that Prosper takes 1% of our 15% for administrative fees.

The Verdict:

When all is said and done, it looks like our effective interest rates will be around 13% for the three years these people have their loans with us. Not bad really. And so, I give Prosper my approval! For most borrowers typical loans are best, but if you have a non typical situation these loans might be right for you. If you are a lender, I would definitely take a look at Prosper. And, if you decide to sign up, please click on one of the Prosper Pictures here, so I get credit for referring you. (If you are going to lend, you get $25 too!)

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