I crowned Amazon S3 as my coolest technology service site of the year (sorry, I can't stop plugging it); now I've discovered the coolest economic service site of the year: Prosper.

Prosper revolves around the concept of microloans and microcredit, which is starting to raise its profile (Microfinance recently 'won' an Nobel Prize). Basically, the site allows people to finance other people's loans.

It's a very simple concept - you're essentially taking the bank out of the equation in loaning; people loan directly to other people. Since most of us can't afford the risk and capital to fund huge loans (like 25K), Prosper allows lenders to aggregate smaller amounts to fund these larger loans.

Here's how it works in a nutshell: Someone who needs a loan (let's say Bob) creates a site on Prosper and provides financial information (home ownership, credit rating, bank information, identity information). Prosper validates Bob's information (to lower the risk of loan defaults and fraud) and then allows Bob to create a request for a loan. Bob may request $10,000 at 20% to pay off a high-interest credit card debt.

Lenders then come in and bid however much they want and the rate they want to submit. A lender bids $100 @ 20%. By the end of the loan request time period, if enough lenders have submitted bids for the loan, the loan is created. Prosper takes a small cut from both sides and then the lendee pays off the new loan (all loans have a length of 3 years) with a monthly fee.

This is really cool for people who can't go through traditional methods to loan money (those with bad credit ratings) or people who want to consolidate their loans. I can see how somebody with a high credit debt would create a Prosper loan at a lower rate and then pay this off. This could also be really useful for raising funds for high-risk ventures that banks would normally not back.

Of course, there's always risks with these sites. Prosper takes one step to protect lenders by providing a credit history and by creating the concept of groups (you can visit the site to see how this works). They also work with collection agencies to try to resolve defaulted loans, but the success rate of these collection agencies seems pretty low (~10% of defaulted loans are recovered). You have to remember that with Prosper, there will be a lot of people who could not get loans from traditional methods (banks) because they are higher risk. Caveat, lender.

For casual lenders like me, this is a great opportunity to make some extra income on some spare cash by loaning it out to people at higher rates than I could get from a bank CD or even investing in the stock market. (Remember that if you can return 15% per year over five years, you've *doubled* your principle) I got my account cleared this past weekend and I've put in a few bids for loans at an average rate of 21% per loan. I've spread the risk by bidding a low amount on many individual loans (the lowest amount you can lend is $50 per loan), thus removing the risk of an individual loan defaulting which would hurt my principle.

I've seen lots of different postings on Prosper - there've been loan requests from people trying to rebuild their credit ratings, buy a second house, pay off a medical bill, consolidate all their loans into one payment; when you read the math behind each Prosper loan and see how much people can save from not paying exorbitant rates on credit cards, you can really see how Prosper benefits a lot of lives.

Microfinancing, as a concept, is a fascinating study on how individuals can impact developing nations by offering an avenue for financial support where most corporations won't dare go. I'm hoping the idea behind Prosper can extend more globally in the future. The UN Capital Development fund has a good site with some microfinance information for those of you who want to read more on this.

In any case, I'll be watching Prosper with some interest; this could really be huge.

Posted by roy on November 7, 2006 at 01:13 AM in Finances | 2 Comments

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Comment posted on November 7th, 2006 at 10:14 PM
You need to update me on how you do on that Prosper site. I may be interested in that.
Comment posted on November 7th, 2006 at 12:07 PM
http://www.kiva.org is connecting people here with entrepreneurs in developing countries.