August 24, 2007

It's been one year since I invested in Prosper and Kiva, two microfinance organizations that pool contributions from individuals to lend sums of money at low interest rates. Prosper lets lenders profit from interest payments. Kiva does not pay interest back to lenders.

So far, Kiva has a better return (0%) than Prosper (-2%). Not one of my Kiva borrowers has missed a payment while two of my Prosper loans defaulted.

Prosper rates borrowers' credit on a scale of AA, A, B, C, D, E, HR (high risk), and finally NC (no credit). Of my two defaulted loans, one was to an HR borrower at 29% and the other was to a B borrower at 15%. I was way too greedy in expecting a 29% annual return from a low-grade buyer, but the B borrower had a modest interest rate and good numbers in general. Prosper's reports suggest that over the past year, there is very little difference in net return over all credit grades: borrowers with poor credit will accept a higher interest rate, but they are also more likely to default on their loans. Of course, those numbers are of little consolation when lenders have only about a dozen loans at any one time.

I've decided to focus more on the higher-grade loans, concentrating on people trying to pay down credit card debts. Business owners are often more emotionally appealing, but the risks are just too high. Then there's the pockets of people who have great credit and want to reinvest: borrowing money at, say, 8% and reloaning it to other Prosper borrowers at higher rates. At an expected return of 9–12%, I'd much rather just put my money into a savings account or an index fund.

I'm not sour on Prosper. It's an interesting idea to emphasize a more personal relationship between borrower and lender. I'm going to stick it out for another year in the hope that better decisions erase a single bad year's results.

And as for Kiva: As long as shopkeepers in the developing world keep paying me back, I'll keep lending to others.