How to Manage Your Risk on Prosper.Com
If you haven’t read my first article on Prosper go back to get a little background first.
For those of you who are reading on from the first article, you can already see the potential Prosper has for earning passive income. Of course there’s still risk involved in loaning money to strangers, so here are some tips to help you make smart lending decisions.
Know Your Default Rates
If you’ve been reading my blog recently, you know that I believe in exploiting probabilities. That’s exactly what you’re doing when you loan money. For example, people with B credit will default 1.80% of the time. So if you make 100 loans at $50 each to A credit borrowers, you’ll lose $100 on average (rounded up to 2%). Here’s how we use that information:
APR Desired: 15%
Money Invested: 100 loans @ $50 ea. =$5000
Money Invested: $5000
Default Rate: 2%
Annual Income: $750 = $5000 x .15
Effective Money Invested: $4900
Then we figure out what interest rate we need in order to earn $750 annually with $4900 invested.
750/4900 = 15.31%
Here’s a table of historic default rates on prosper.
Know Your Borrower’s Debt to Income Ratio
Debt to income ratio is determined by dividing a borrower’s fixed monthly expense by their gross monthly income. Ideally your potential borrower should have a debt to income ratio of 20% or less. The higher a borrower’s debt to income ratio, the higher the lending risk. You’ll need to take that into consideration when determining what interest rate to accept.
Follow the Money
Where are all the seasoned members of Prosper putting their money? That could be a good indicator of where the good bets are. Look for loans that look like they have a good chance of being fully funded.
Diversify, Diversify, Diversify
No matter how careful you are, you will have loans default. It’s a statistical certainty. The good news is that if you followed my advice, your portfolio is prepared for it. In fact, your portfolio is expecting default.
If you’re not properly diversified you’re gambling. You need to spread your money around to as many loans as possible that meet your criteria. For example, $1000 should be divided into 20 loans at $50 each rather than one loan of $1000.
Prosper.Com offers the average person the opportunity to make money in lending. As in all investments there is some risk involved, but with proper risk management you can earn returns far above the market average.
Ready to start? Join Prosper.Com and get a $25 bonus!
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