Microfinance For Profit with Prosper

It's been about a month since I signed up with Kiva, a microfinance organization dedicated to providing loans to entrepreneurs in developing countries. Since then I've received feedback from three of the four entrepreneurs to whom I've lent money: Bazar Edgar of Guayaquil, Ecuador; Mariscos Don Felipe of Guayaquil; and Nen Phan of Dangkao District, Cambodia. Nen has also repaid $166 of the $1,000 she was loaned.

Of course, microcredit is at its core a business and not a charity. Kiva does not pass along any of the interest to funding partners like me, instead letting the local firms which actually make the loans charge interest and collect the payments. That brings me to Prosper, an unabashedly for-profit site that caters to Americans who want to borrow money from their fellow man.

Prosper uses a Dutch auction scheme to determine how much interest a borrower is charged. Lenders, like me, bid on portions of a loan with an interest rate. The lowest interest rate is used to determine who wins a share of the loan, but the actual interest rate charged is the highest rate bid. Example:

Alice wants to borrow $1000. Bob bids $500 at 10%, Carol bids $500 at 9%, and Dave bids $500 at 8%. Carol and Dave win 50% shares of the loan, but the loan is issued at an interest rate of 9%.

Because lenders actually own a share of the loan, the warm-and-fuzzy feeling of Kiva gives way to the reality of business. The sign-up process at Prosper required several days and many pages of legalese, whereas Kiva just tied in with my PayPal account for funding. I have to designate a collection agency for every loan I make. Due diligence is limited to a page that would-be borrowers publish on Prosper. Many high-risk borrowers request interest rates of about 20%, but an average default rate of 19% means that I'd only expect to receive a net 1% on average. (Loans that end in default can be written off as capital losses on my income tax, but it's not like all the money will come back to me.)

Nevertheless it seems like Prosper is an unusual but potentially lucrative social experiment. I found that I got outbid fairly frequently when bidding on many conventional loans, so going after the "hidden gems" -- high interest rates from reputable-looking borrowers -- might be profitable. Prosper also lets you place a standing order to automatically bid for loans at a particular interest rate for certain credit ratings of borrowers. With a standing order I was able to gain several small loans.

Both Kiva and Prosper stress the importance of diversifying. I stand a better chance of getting 18 out of 20 $50 high-risk loans repaid than of getting one $1,000 loan repaid in full. The bookkeeping is seemingly complicated but of course it's all hidden behind a shiny HTML façade.

The best part, though, is that Prosper and Kiva combine to make for a portfolio unusual in its cultural diversity. I could take the money I make off American credit card consolidation loans and parlay it into loans to third-world entrepreneurs -- all without leaving my seat at the coffee shop.