I have been reviewing through a large number of Lending Club loans and noticed some humorous descriptions of the reasons why people want the loan. These should serve as advice for anyone who is planning to write up a Lending Club loan application. Remember that most all lenders are investors and want their money back with interest. The main reason that people loan borrowers money is not because you need it but because they believe that you can and will pay back the loan.

Loans are similar to requesting a tourist visa to come to visit the US — the person deciding whether to give the potential visitor the visa wants to know the reason you want to visit mainly to see that it is reasonable. The main thing that they want to know is that you plan to return to your country after you visit.

• You need to say SOMETHING in your loan reasoning. Loans numbered 76775, 89258 have the description field left entirely blank and even the subject line does not give any indication of what the money is for. Loan 76775 was not funded but the other one was.
• A loan should not be an income supplement. “I just need something that can help me supplement my income a little” People do not loan you money for your day to day income. If you cannot make your current obligations, how are you going to pay off the loan? Loan 74288 was not funded.
• Don’t mention that a good portion of the money is to pay your debt to your therapist. At best, it looks like you may be allowing someone to take advantage of you by putting you that much in debt. At worst, it makes you look like you might be unstable. Loan 81682 was not funded.
• Don’t mention that you are not going to change your free spending ways and will continue to spend money that you don’t have. “$3,000 to pay off credit cards with insanely high rates, and $2,000 just so I can go on vacation with my friends and not have to stay at the hotel because I can’t afford to do anything.” Did you think that maybe you should tell your friends you can’t afford go on vacation. Loan 77680 was not funded. I wonder if he want on vacation anyway.
• If your want a business loan, at least tell lenders what the business is and how you plan to make money: “Initial cashflow to jump-start operations on small scale.” Loan 94517 did not fund.
• Do not mention that it is for a down payment on an item without mentioning how you are going to pay for the rest of the item. “down payment on a Pony!” This is not an excerpt from the application — it is the full description. Loan 76597 did fund in July 2007 and is current.
• Don’t mention that your parents will not cosign on the loan for you because it makes me think that your parents believe that you cannot pay back the money. “…and my parents refuse to help me by cosigning.” Loan 77915 did not fund and was removed.
• Don’t beg for the money — Desperation for the personal loan makes you sound like a poor credit risk. “I desperately need this loan.” Lending Club Loan number 103810 expired without being funded.

I hope that these examples of mistakes in personal loan applications might help you make a better description on your application which should help you have a greater chances of receiving funding for your loan.

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This is the second post in a series on my recent experience applying for mortgage refinancing.

While applying for mortgage refinancing, I asked the loan officer for credit score wisdom based on her experience. I knew most of the advice but I found some of her comments interesting so I’ll post the collection of advice, tips, and cautions:

• A hard credit pull negatively impacts your credit score. A hard pull is a loan application that would result in credit if approved. If you check your own credit, it is a soft pull and does not effect our credit score.
• Check your credit score three times per year for incorrect information and dispute incorrect information. My additional note: be sure to request your credit score through the official site rather than one of the many services that has sprung up. The FTC has a warning on this issue. Checking your own credit is a soft pull which does not impact your credit score. You will not see your FICO score without paying additional money but the most important thing is to check for incorrect information.
• Three to four credit applications in a short period of time for a home loan will count as one hard credit pull. This was not the case in the past when shopping around for a loan could hurt your credit score by causing a high number of inquiries.
• Fixed monthly payment loans (cars and houses) hurt your credit score less than variable payment loans and unsecured debts.
• People who are denied credit often continue to shop for loans which only further lowers their credit score due to the number of recent inquiries. They should find a way to avoid requesting credit for a some time and try to increase their credit score. My note: If you are denied once or twice for a loan, stop asking a bank and check out Prosper.com or Lending Club for a person to person loan instead of going through a bank after one two denials.
• Plan ahead for trouble by applying for a cash out refinancing loan before you lose your job if you think you will or before your payments start becoming late. My advice: build up an emergency fund.
• The credit union where I applied pulls all three of your credit scores (Experian, Equifax, and TransUnion) and uses the middle score.
• If you and your spouse apply together, the credit union uses the lower of you and your spouse’s middle credit scores.
• Both spouses can be on the deed to the property and only have only the spouse with the higher credit score apply for the loan if one spouse has much lower credit. This may be a good idea now that brokers are charging delivery fees on mortgages for lower credit scores.
• Many elderly people run into credit and financial problems by bailing out or co-signing on loans for their middle aged kids or for their grandkids.
• In the case of divorce (even if only one party is on the loan), both people must sign for refinancing. This prevents one spouse from selling the house without the other spouse’s knowledge. However, this also commonly prevents a cash out refinancing at the time a person most needs the cash. (I noticed Lazy Man also posted on Mortgage and Divorce.)
• If applying for a HELOC (home equity line of credit) and refinance your mortgage around the same time, refinance the mortgage first and then apply for the HELOC. The HELOC will negatively effect your credit score more than the mortgage.
• At the credit union where I applied, they will use the same credit report pull for 120 days, so you do not need to add an additional credit check to your credit report if you refinance and then immediately apply for the HELOC with the same bank.
• Cash out refinancing has become more expensive. I explained the extra charges in the post about delivery fees.

Lazy Man and Money recently posted a credit score hack explaining how to use Prosper.com to raise your credit score.

Wise Woman Investor recently posted Four Credit Tips to raise your score:

• Buy your FICO score
• Pay Bills on time
• Reduce your debt
• Don’ open or close any credit accounts

In my opinion, buying your FICO is a good idea if you are planning to by a house, but simply buying your score will not help raise it. The other three tips are sound.

Note: Some of this advice could be state specific or bank specific so check with a loan officer in your area. The one that I spoke with was very helpful in dispensing free credit score and loan advice.

Technorati Tags: mortgage, credit score, credit report, refinancing, loans, HELOC, credit union, borrowing money, credit agency, FICO, credit crisis

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This is part one of a series of what I learned by talking to a mortgage broker last week.

I stopped by my credit union to check into refinancing my mortgage last week. The rates were low and with the likelihood that the fed was going to drop rates again, I decided this might be a good time to refinance from a 30 year fixed to a 15 year fixed interest rate mortgage.

I asked the mortgage broker many questions about the current mortgage market. She passed along some interesting information including the details about a new mortgage delivery fee. I have no plans to cash out, but I continued to ask questions around all options to learn more information. The mortgage broker showed me a large binder with a new set of guidelines from Freddie Mac that determine the interest rates that she can offer. There will be even tighter restrictions coming out on June 1st, 2008, so rates will likely rise even further for higher risk borrowers soon.

In the past, the loan officer told me that she could nearly always quote one rate and it was applicable to nearly everyone who walked in the door. That to me indicates another problem with the mortgage market — too many borrowers were treated as equal credit risks when they were not.

This information applies to Freddie Mac (FRE) mortgage loans which the credit union uses to back their loans. If you credit score (FICO) is above 680, there is no delivery fee on non-cash-out refinancing. I have a FICO score above 680, so there is no issue with the delivery fee for me. The rates start to rise about the published rate as the credit score drops below 680.

Cash-Out Mortgage Delivery Fees
There are additional mortgage delivery fees based upon the LTV (loan to value) ratio. To simplify somewhat, if the loan is a 70% – 80% LTV ratio, the delivery fee is 0.5%. On a $100,000 loan, that would be a fee of $500. If the LTV ratio is 80 – 90%, the fee is 3/4 of a point or $750 per $100K borrowed. That is a very expensive fee for a borrower needing to cash out $10K to pay off some credit card debt. Of course, most P2P loans have an origination fee, but on a $10K loan, you could expect to pay 0.5% to 2% or $50 to $200 in origination fees. The origination fee savings will be offset because you will likely pay a higher interest rate on a P2P loan and the interest paid is not deductible from your federal income tax. Therefore, the equation is complex for me to give specific recommendations, but all these fees may make P2P loans more attractive to borrowers with good credit scores.

I asked about also applying for a HELOC
I asked about applying for HELOC in addition to refinancing the first mortgage. The broker advised applying for the HELOC after refinancing the mortgage, but within 120 days because they would not need to pull an additional credit report within 120 days. That would save a hard-pull on my credit report which would impact my credit score. These additional fees are going to make P2P lending options such as Prosper.com and Lending Club, more attractive to borrowers who would have traditionally applied for cash out refinancing — even if the borrower has good credit.

BankRate confirms what the mortgage broker was telling me. The article also mentions “Risk-based pricing has arrived.” Interestingly, the new new risk tables (see Freddie Mac’s) remind me of the Lending Club rate tables. Freddie Mac has posted some long PDF files (1, 2) that explain the details of the delivery fee calculations.

Technorati Tags: p2p lending, p2p loans, mortgage, mortgage crisis, Freddie Mac, FRE, refinancing, mortgage broker, delivery fee, HELOC

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I returned to the Zopa lending site today for a second impression after my initial review of Zopa. I noticed something that knocked my socks off about Zopa’s business model of social lending — some borrowers are not paying interest after receiving “help” from lenders. In fact, some borrowers are “paying” negative interest at Zopa! In other words, they are receiving money for having borrowed money. This is an amazing development in P2P lending!

The proof in the Zopa homepage screen shot below. I cropped out part of the screen (red line) to make the graphic smaller and added three blue checks to show you the borrowers that I am highlighting below as examples. Click the thumbnail below to see it in more detail.

The three borrowers that I am highlighting (blue checks in graphic) are:

1. TinaM who is borrowing $5,000 to go back to school with a started interest rate of 9.99%. Currently TinaM is receiving help of $70.
2. wlaffin who is borrowing $5,000 to pay off credit cards at a stated interest rate of 12.99%. Currently, he is receiving help of $66.
3. Rugsaq who is borrowing $10,000 to grow his transportation business at 12.99% stated rate and is receiving help of $70.

Note that the links are to the profile pages which do not include the loans and the help amounts. The loans, interest rates, and help amounts are listed in the graphic above.

Calculating the actual interest rates…

Since most web-based loan calculators will not allow you to solve for the interest rate, I used Excel solver together with the interest rate spreadsheet from this website. Since I do not know the length of the loans, I must make some assumptions: 1) The length of the loan is two years 2) and the help will continue for the life of the loan. Additionally, for simplification, I have rounded dollar amounts (not interest rates) to whole numbers and I have only linked to my spreadsheets for the first example.

1) If TinaM is paying a stated 9.99% interest on a 24 month loan, the payment is $230 per month with total interest paid of $537. The monthly interest rate is 0.8325% (9.99%/12). (XLS file) Since TinaM is receiving help of $70 per month from lenders, I used the same spreadsheet to solve for (goal seek functionality) the interest TinaM would be paying on a $5,000 loan if her payment was only $160 per month. The actual interest rate TinaM will pay is negative 24.15% and she will actually be paid $1,160 for having taken this loan. (XLS file) TinaM will only pay $3,840 for her $5,000 loan because lenders will giver her a little help.

Perhaps the best method of showing the difference is to show the two graphs of the loans. Note that the interest rates listed are the monthly interest rates. The first graph is the stated rate of 9.9% and the second graph is the effective rate of negative 24%.

2) Using the same calculations and assumptions, Zopa user wlaffin is not paying 12.9% interest annually with a payment of $237. Instead, due to the help of $66 per month, he is receiving a loan at a negative interest rate of 18% and receiving $885 for having taken out this loan.

3) Since Zopa borrower Ruqsaq is requesting a $10,000 loan for business expansion, I am going to change the assumption to a 3 year loan term instead of 2 years to calculate his effective interest rate. At his stated interest rate, he would pay $336 per month and $2,112 total in interest. The actual interest rate he will pay with $70 in help is a negative 2.79% per year. The monthly payment will only be $266 and he will receive an effective payment of $424 for having taken out this loan.

Unfortunately, not all borrowers are receiving much help from Zopa lenders, so negative interest rates are not standard. In fact, many people seem to be receiving little or no help at all. However, the average help according to the home page* is $22 per month, so it is still a good idea to borrow money with Zopa versus other P2P lending sites. The other sites, such as Prosper and Lending Club, do not offer the possibility to pay negative interest on your loan.

* Zopa home page lists $22/month help as average as of December 9th, 2007.

zopa, p2p lending, interest rate, help, money

Technorati Tags: zopa, p2p lending, interest rate, help, money

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As I browsed Prosper loans, I was surprised at the number of community members who would like to use their good credit score to borrow money in order to reinvest the money in other P2P loans. This is called leverage and by definition it does increase risk. Is it a strategy that is likely to payoff?

The borrow-to-lend strategy was referenced before in an article on OmniNerd. As of this posting on the Prosper website, LeedsGirl (AA credit) is looking for $2,500 to reinvest in Prosper loans. Bpyatt is asking for a similar loan for $10,000 at 11%. MoneyDoc99 (AA credit) is borrowing money to reinvest as part of a Doctoral project. The list of people doing this goes on, and on and on. In fact, at least 5 of the 25 people who appeared on the first page of loans were lenders borrowing to reinvest in prosper loans. Another person on the front page is reinvesting in the Chinese stock market. The funniest part is the text of this loan request, which is already completely funded at 12%. Engle writes in his loan request:

I recommend this investment to anyone with $5,000 USD sitting around. The USD will continue to depreciate in the next few years… Since I do not have the capital to readily invest in foreign markets, I am request this loan to fund my “riskless” investment in the Chinese currency and market.

It sounds like he would also recommend this investment to anyone — even if they do not have $5,000 laying around to invest. I would certainly not call the investment without risk. If it was a “riskless” investment, it would pay the same rate of return as a US treasury bond. Maybe he forgot about the Asian financial crisis which occurred only about 10 years ago. I would question anyone’s investment acumen who calls an investment in single market on borrowed money “riskless.” Personally, I have been increasing my stock percentage in foreign funds due to the likelihood that the dollar will continue to depreciate, but it is certainly not a strategy without risk.

I am calling the strategy Borrow-t0-Lend, but many of the people on Prosper trying the strategy label the practice “Borrowing to Reinvest.” Other lenders call the people who borrow to lend “Blenders.” So is it a good idea to use your good credit score to lend to others with a lower credit score?

Take a $10,000 loan on Prosper and you will actually only receive $9,900 so you start out 1% behind. The interest rate at which people seem to be receiving these loans varies from about 8% to 11%, so I will use those sample interest rates as examples in my calculations for the ROI on this borrow to lend strategy.

Next, you must reinvest in various loans and earn a greater return on lenders with a lower credit score who require a higher interest rate to receive funding. For simplicity, I will use the highest sample number from Prosper’s own sample portfolio charts:

I’ll give you the best case scenario, 11.5% RIO which had an initial stated interest rate of over 20%! I do not completely agree even with the 11.5% figure for reasons explained below. Let’s examine your profit for the three year period on borrowing from Prosper to reinvest in Prosper loans. Best case, you were able to borrow at 8%, but that cost you 1% of the loan value as a borrowing origination fee to Prosper, so you will likely earn the difference between 9% and 11.5% on $10,000. The most likely case (according to the data presented at Prosper) will earn you a return on investment of only 2.5% or $250.

If you must borrow at 11%, it is highly probable that you will lose money. By the numbers, you will lose 0.5% due to the origination fee on the borrowed money. A predicted loss of $50. A loss that also puts your good credit rating at risk.

I can hear the response from a few readers already: “But I am great at picking loans based on the information provided and don’t use the standard portfolio selection tool. Currently, I am earning X percent!” But what is your time worth? There is an opportunity cost to sorting through the loans on Prosper. Also, how long has the average loan been outstanding in that portfolio?

I fear that people are borrowing-to-lend based on too little data. Imagine the investor who has tried out a P2P lending network like Prosper for a year and had great success — maybe a 14% return with very few defaults. The lender might decide to take on the borrow-to-lend strategy to increase returns based on this data. However, that lender is still missing two years of data to determine the actual return on his investments. It is highly probable that other loans will default and there is always the possibility that economic conditions could change. Take the possibility that some of those borrowers will have an adjustable rate mortgage where the interest rate will reset causing foreclosure. By the time year three ends, the lender will not have a 14% return. Even Prosper’s own disclosure states (as also discussed on the Prosperous Land blog) that the default rate is based on a short time frame (only 16 months) considering that we are discussing three year loans (36 months):

Estimated average annualized loss rate based on the historical performance of Prosper loans for borrowers with similar characteristics, originated between Jun-01-2006 and Sep-30-2007, measured as of Oct-24-2007. Actual performance may differ from estimated performance due to many reasons, for example, worsening economic conditions.

Furthermore, both Fred and Lazy Man and Money pointed out that Prosper is occasionally posting misleading information (lazy man money link), so the data listed above, which is not rosy, may be whitewashed. Prosper also stated in a response to Fred that people have misrepresented their own rates.

This is making me wonder if Prosper is actually an efficient market? It seems players may be underestimating risks and basing decisions on too little data.

In my opinion, the borrow-to-lend strategy is not worth the risk to your personal credit score and is irrational market behavior. However, I doubt that Prosper will stop this strategy because they earn fees on both sides of the transaction with no risk since borrower and lender are assuming all credit, economic, and interest rate risk.

I expect someone to appear and comment who has tried the strategy and is doing great, but I want to talk to you about the final numbers at the end of three years of your borrow-to-lend strategy. With great probability, you will be sorry you tried it. Well, with the exception of the Doctoral student, the probable loss may have helped him earn a PhD.

Update: I ran across the borrowers who lend page and LendingStats.com. I drilled down on the person’s name and in many cases the estimated portfolio return was less than the person was paying in interest as a borrower. Of course that does not mean that all the people on this list were attempting to follow this strategy. Additionally, someone could have made a bad initial loan or two and have learned from mistakes. Those initial bad loans could be dragging down the portfolio returns.

Update2: Tom at Prosper Lending Review pointed me to his article on the same subject, borrowing to lend, that you may also interest you.

• Lending Club ROI Bonus: 5% extra return as a “Thank You!”
• Review of My First Loans with Lending Club
• Examining the Lending Club Risk Rating Score
• My First Lending Club Payments All on Time
• Financial Risks in P2P Lending