The Main Reasons To Borrow Money Through Peer-To-Peer (P2P) Lending

Borrowing Some Needed Cash Everybody needs to borrow money some time. Peer-to-peer lending is a good alternative if you don’t want to pay usurious rates from loan sharks, if you’ve been denied a loan by your local bank or credit union, or if you are just too embarrassed to ask someone you know for help. From $1,000 for an emergency medical bill to $15,000 to pay for an engagement ring, some reasons are more legit than others!

As an investor in P2P lending, it’s always a good idea to set parameters on what type of person you plan to lend to. As P2P lending is primarily going to replace my low risk CD income that’s coming due, I intend to focus on low risk borrowers with high ratings between C to AA. They’ll probably pay rates of 6.59% to 15% so I can make a 4-10% return. An important part of understanding a borrower’s risk profile is to therefore understand what they plan to borrow money for!

I highlight all the main reasons why people borrow money through peer-to-peer lending. These are actually selections for borrowers to choose from on Prosper.com. I bucket the reasons into four categories (Great, Good, Borderline, Suspect) and analyze each reason from a borrower’s point of view. As a potential borrower in P2P lending, you can then decide whether you want to go forward with borrowing based on my rationale. The same goes for lenders when selecting loans to fund.

GREAT REASONS TO BORROW VIA PEER-TO-PEER LENDING

Debt Consolidation – Debt consolidation is by far the best reason to borrow via P2P lending. If you have a loan shark charging you 20% interest a month, or if you have stubbornly high credit card debt at 29.99% a year, borrowing money through Prosper.com to consolidate your debt is a financially good idea.

Let’s say you’ve racked up $50,000 in credit card debt at a 29.99% annual interest. Your credit card company loves you, but you’re just falling farther and farther behind if you only pay the minimum $1,500 a month. Let’s say you have a job, a good profile, and decent credit rating of around 680. You can likely cut your interest expense down by 10-15%, thereby saving $5,000-$7,500 in interest expense alone. Lower interest expense will in turn help you pay off your debt faster. Meanwhile, the more reliable you are in paying off your debt, the better your profile, and the lower the rate you could get on Prosper.

Baby & Adoption Loans – I’m a big believer in adoption. The world has over 140 million orphans who could use some help! The government currently gives an adoption credit of around $12,150 per child. Sounds like a decent amount, but that’s a one time credit and raising kids can be expensive.

If the choice is between letting your baby suffer and borrowing money at a reasonable rate to survive, then clearly it’s better to borrow money. Investors will likely be much more sympathetic to baby & adoption reasons. As a borrower, please be honorable in your use of funds and spend the money on your baby or adoption.

Medical / Dental – Goodness forbid nothing major ever happens to us, but statistics show from long-term care insurance studies that one in five will have some sort of major medical issue. No matter how healthy you eat or how much you exercise, genetics do not discriminate between rich or poor, and accidents do happen.

Dental work is also somewhat of a crapshoot. I grew up wearing braces for a couple years as a kid. I also went to the orthodontist to also get all four wisdom teeth pulled as well as a couple random teeth that weren’t supposed to be there! Going to the orthodontist was routine torture, but I’m extremely glad my jaw and teeth are fine now. It might sound shallow, but crooked teeth and a major overbite may have lessened my chances of getting a job or having a good love life. Such dental expenses must have cost my parents over $3,000 dollars.

GOOD REASONS TO BORROW VIA P2P LENDING

Taxes - If you don’t pay your taxes, you incur penalties and interest. If you don’t pay your taxes long enough, the government will come after your other assets and make your life difficult. And if you never pay your taxes, you will go to jail! Taxes are inevitable and the government’s way of imprisoning us all. If for some reason you haven’t kept up with your taxes, borrowing money is often times the only way to go.

Business – I believe in the American dream, which is why I quit the corporate world at the age of 35 to work on my own business. What I’ve found is that being an entrepreneur is brutal. The government doesn’t make it easy on us with all the taxes, paperwork, and regular filing. Meanwhile, business cycles themselves can be very difficult. Competition could come out of left field and eat your lunch. A competitor might steal your idea. Hurricane Sandy might blow down your business or you could get robbed. Unfortunately things happen all the time. Borrowing money to keep your business afloat, to buy material, to pay employees, to beef up marketing are all respectable reasons to borrow money. Banks clamp down at the wrong time when business get tough.

Home Improvement – This one is borderline good and suspect for me. Many people took out Home Equity Lines Of Credit (HELOCs) during the housing bubble and went crazy. The bubble burst and these folks lost their shirts. If you live in an area where land and the price per square foot selling cost is high, then it makes sense to expand and remodel. For example, my area in San Francisco has an average selling price of around $800/sqft. I can do a high quality buildout for $300/sqft or less, meaning I’ll get a 160% return on my investment!

The only remodels I recommend are kitchens, bathrooms, and necessary infrastructure upgrades for security purposes. Getting new double-paned windows are also nice, but costly. Everything else, I’d be hesitant to borrow money. You will very rarely ever get more than 80 cents on the dollar back on your remodeling expenditure.

BORDERLINE REASONS TO BORROW VIA P2P LENDING

Auto – Unless your car is an absolute necessity to earn money and survive, borrowing money to buy a depreciating asset is not a good idea. I happily drive a 12 year old, $5,000 automobile, and girls still give me the time of day. If you already have a high auto loan, then paying off your auto loan with a lower interest rate loan through P2P lending is a good idea. I know it’s tempting to get a sweet ride (I bought 8 cars in 10 years myself), but if you’re spending more than 20% of your income on the value of your car, then I would focus on making more money first.

Motorcycle – I’m a fan of motorcycles and have my M1 license. They are cheaper, get great gas mileage, and can be parked anywhere. The problem is, they are also much riskier than driving a car. You can get a great motorcycle for under $5,000. Scooters are around $3,500 for example and those are used the world over for long mileages. Getting a loan to buy a motorcycle is better than getting a loan to buy a car simply for the fact that you’ll borrow less and spend less money to maintain your motorcycle. Just make sure to go to M1 school, not run yellow lights, look both ways, avoid weaving between cars, and not brake too heavily on turns!

RV – This could be good or this could be bad. RVs are not cheap, but if the RV is going to be your main home for an extended period of time, getting a Prosper loan is just like getting a mortgage, but you can’t write the interest off your income. Taking the great American roadtrip sounds like a blast!

Green Loans – This is a tricky one because it is a little vague. A green loan can range from buying enough trees to plant around your house, to starting an organic food eatery. Borrowing money for solar panel systems to heat your home is a noble cause, especially since many states provide credit to the homeowner. I’ve upgraded my heating system in Hawaii with solar panels and so far so good. You’ve got to really think about the returns aspect of your green loan first. I notice some borrowers using Green Loans and Adoption Loans as a way to gain sympathy from investors.

Cosmetic Procedures – When we look good, we feel good. I get it. But, beauty is only skin deep unless you need major orthodontic surgery like me as a kid! You’d best use the borrowed money to improve your education or communication skills rather than your looks. Eat healthier, eat less, and go exercise 3X a week are obvious low cost alternatives. Although, if you want to get into an industry which emphasizes looks, then borrowing for cosmetic procedures seems more appropriate.

SUSPECT REASONS TO BORROW MONEY VIA P2P LENDING

Boat – They say the two happiest moments of a boat owner’s life is when he gets the keys and returns the keys. Getting a boat is a true luxury. Maintenance costs are high depending on the size of the boat and you’ve got to pay a monthly docking fee if you live in a big city by the water.

Vacation – Everybody deserves a nice vacation. But, if you need to borrow money to go on vacation, consider a staycation instead. Vacations usually last two weeks or less, while your debt repayments could last months or years. Focus on doing fun things locally like hiking, biking, exploring free museums and parks during the weekdays and so forth. You’ll surprise yourself.

Engagement Ring Financing – You probably don’t want to start your marriage off with debt, or more debt. If your bride to be loves you, she’ll understand if you can’t get that big rock she’s always wanted. Instead, consider getting her a diamond alternative ring, and tell her that as soon as you make enough money, you’ll “upgrade” her wedding ring to something else. She should be touched with your transparency and intent. If she’s not, reconsider your proposal!

Wedding Loans – The average American cost of $25,000 is somewhat absurd given the median household income is around $50,000. I guess if you guys and both sets of parents pitch in, that’s “only” $8,350 each for one day worth of happiness, but still. $8,350 is a lot! Think about all the better things you can use $25,000 on: paying off student loans, a downpayment, travel, a kid’s education and more. A wedding is special. I don’t think folks should borrow more than $5,000.

For those looking to do a deeper dive into the performance rating by reason for borrowing, you can click this link.

BORROW MONEY RESPONSIBLY AND WITH GOOD FAITH

Borrowing money via P2P lending is best for those who want to lower their existing interest rates through consolidation. Thanks to the economic downturn, many people have been shutout from commercial bank borrowing despite being good people. P2P lending offers a second chance for millions of folks to get back on track. For P2P investors, we have a chance to increase our returns in this pitiful low interest rate environment while doing some good at the same time. If you would like to seek higher returns with Prosper as an investor you can click here.

You can borrow money via Prosper here. Borrowing money via P2P lending at ~6.5%-10% is way cheaper than borrowing with a credit card which often charges well over 15-20%. Debt consolidation via P2P lending is also a smart move. Just remember that if you borrow money, you must pay your lender back.

About the Author: Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 35 largely due to his investments that now generate over six figures a year in passive income. Sam now spends his time playing tennis, spending time with family, and writing online to help others achieve financial freedom.

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. says

    Great post Sam. I big believer in loans for the right reasons and I like the way you have split these up. In todays low interest environment it makes a lot of sense to use other peoples money to get ahead and P2P is a great option. Thanks! Quinn

  2. says

    The number of green loans on P2P sites astounds me, especially the requests for funding to buy solar panels, etc. Not only do solar panels get cheaper by the day, but there’s no way to make a home solar panel project produce an MIRR even close to the actual cost of a consumer loan. I went through the P2P data site (can’t remember it off hand) and I think those loans had the worst default rates.

    Debt consolidation is undoubtedly the best for borrowers and lenders alike. Once fulfilled, the borrower gets more cash flow each month and the lender has a much better margin of safety because of it. Win-win!

    • says

      With Obama getting re-elected, I’d think at the margin home solar panel investments should uptick. Got some rooftop solar panels myself in Hawaii to heat the water. Not cheap, but on par thanks to government credit.

  3. says

    It’s outrageous how expensive medical and dental expenses can be. They’ve certainly crushed my parents finances and if you need care there’s not a whole lot of options. You usually just have to get treatment and hope it doesn’t get you bankrupt. I agree that wedding expenses aren’t a good reason to borrow. Couples shouldn’t start their marriage by going into massive debt for a wedding beyond their means. It will only lead to stress, a strained relationship, and burdens.

    • says

      Sorry to hear about your parents finances. Hopefully the Affordable Care Act and Medicare can help them? I hope so. I don’t think it’s right for a nation as rich as ours to allow people to get financially blown up due to healthcare costs.

  4. says

    Setup your lending in tranches, allocate more to prime loans and less to subprime and dogs, you will reduce your risk by insulating high returns and high default rates with lower interest rates and lower default rates, organizing a portfolio with higher returns with only slightly higher risk is fairly easy. Also the lower rate loans are far more likely to prepay and reduce your rates further, you need to lend to all credit grades proportionally or you will not hit your target rate.

  5. says

    Great break down, but as a lender I care more about getting paid back. Can you get some data from Prosper on which type of loans are better in that regard? I’ve been mostly lending to home improvement loans because I figure if they have a house, they stand a better chance of paying back.
    Baby and adoption – If you can’t afford the fee, perhaps you shouldn’t adopt. A baby will cost a lot more than the upfront fee.
    Medical – I generally avoid medical loans too. What happens if the person… you know…
    Debt consolidation – some time. Usually they owe so much money that I’m afraid to lend it to them.

    • says

      Getting paid back is my #1 concern as well. I would invest all day at the High Risk category who borrow for the silliest of things if I knew they would pay the money back. But, that’s obviously not the case.

      I hope borrowers who are looking to borrow via P2P can read this post AND comments with an open mind before borrowing. My goal is to decrease the amount of defaults. I will get some data from Prosper on your question. Thanks!

      • says

        Thanks for that. At first glance, it looks like home improvement has less charge off than Auto and debt consolidation. Baby, wedding, and medical seems like they are too new to be accurate.
        The 5-6% charge off rate seems low to me. I thought the default rate would be higher from talking to other investors.

  6. says

    I disagree with Taxes and Businesses being “good” loans. Both seem very risky from the standpoint of me, the investor getting my money back. If someone falls behind on their taxes, how can I be so sure they won’t start to fall behind on their loan payments. The same goes for the business. If your business goes under, as most do. How are you then going to pay me back? IMO I would be staying far away from those two types of loans.

    • says

      I’m writing mainly from the standpoint of the borrower. I want to understand the other side first before I invest. I do this with all my investments and negotiations. I can see your point from a lender’s perspective. Everything is relative, and a new post will be about the required rate of return for such loans.

  7. elai says

    A lot of credit card companies offer $2000-$20’000 %0 APR credit cards where the %0 lasts for 1 year. With that kind of consumer debt available, it’s kind of hard to compete. At what level do banks start offering that kind of APR? I’ve gotten it with a credit rating in the 600s

  8. Chris says

    15,000$ for an engagement ring!!? I can’t think of a worse way to start a marriage. I have a theory, the bigger the ring, the less stable the relationship.

    • says

      I spent double that on my wife’s engagement ring; however I paid cash and was still living beneath my means. We just celebrated our 5th wedding anniversary and are looking forward to the next 50.

      By the way the diamond has since appraised for about 20% more then I paid in 2006, it needs to be re-appraised every few years for the insurance policy, we would never consider selling it, still nice to know it has maintained its value.

      I would never suggest spending more than you can afford on a diamond, that is fiscally irresponsible and money issues is the number 1 reason for divorce, followed by infidelity, there are numerous statistic to prove this, no need for theories.

      Dogs are man’s best friend and Diamonds are a girl’s best friend.

        • says

          We used to live in the city, we moved to the burbs back in 2009 got a house near where we grew up.

          I work in the city midtown on the east side, my wife used to work uptown.

          2 carats ha… We are in our 30’s so we are closer to 3 :)

        • says

          2 carats … 3 carats … that’s insane to me.

          I spent a total of about 12 hours trying to buy my wife’s slightly under 1 carat diamond. I even changed the style at one point. It’s increased it’s value, since the clarity is so good (I think it was incorrectly marked at the time).

          But to each his own, and it’s your wife you have to sleep next to every night, so do it right the first time! :-)

        • says

          My engagement ring cost $400. It is a sapphire with a few small diamonds on the sides. My husband was poor when we got engaged. Now that we have more money I could upgrade my ring if I wanted to. I love this ring though. It reminds me of our humble beginnings and I wouldn’t trade it for the biggest diamond in the world. Some women don’t care about how much a wedding ring costs or where it came from!

  9. says

    Interesting analysis! I would think that all the P2P borrowing is subprime candidates. AA wouild indicate otherwise. Why would such a good credit use P2P? Is it convenience and speed?

    • says

      Convenience and speed is definitely one of the main reasons. Everything is done online, whereas for a commercial bank, you’ve got to make an appointment, go to the appointment, plead your case, show your physical docs, wait a while, etc. The internet has truly streamlined things.

  10. says

    I think P2P is great for both lenders and borrows but borrowers should be responsible and pay back those loan and lenders need to be cautious of the risks. I dont really like the borrowing for autos and vacations etc. If you didn’t save for it don’t go. But at least you are the first I read the viewed it from the side of the borrowers.

    • Investor Junkie says

      If I were to invest in these loans (I don’t but just saying), I would put them in their own group to track their ROI.

      As much as I like helping small businesses grow, this isn’t it.

  11. says

    Thanks For the low down on p2p, Sam. I’ve been having a heck of a time refinancing my home in order to re finish my foundation (kind of important!). I am seriously considering p2p. Thanks!

  12. says

    Peer to Peer lending makes a lot of sense. I have never invested in P2P lending or used it but cutting out the middleman only makes sense. The success/failure of P2P lending is all up to the system and how well it works at ensuring people both A get the money and B pay back the money.

    From the looks of it Prosper.com is doing a lot of things right!

    The potential for student loan consolidation that doesn’t require a cosigner is a big plus for many graduates and something I will have to look more into.

    Some items on Propser don’t add up…why would someone borrow $4k at 30% for home improvement? The answer to me is that their credit history is so bad they were unable to get another credit card to max out….I would definitely stay away from people promising returns higher than 20%!!

  13. says

    I’m a lender through both Prosper and Lending Club. The reason lenders can earn such high returns is that the money invested is not very liquid. If you want to sell your existing loans, it might take awhile to get your cash back and you might lose some principal. That said, if you invest money you know you will not need returned for a few years, its a great way to help out others and make a decent yield.

    The borrowers pay really high rates because the rates a P2P are lower than they must pay on their credit cards.

  14. says

    While doing my own research before investing over at Lending Club, I read somewhere that “business” is a very risky loan category. The reason being, that so many businesses fail, especially if the money borrowed is for start up. For me, I slide that category down to Borderline, if not Suspect.

  15. says

    One of the advantages of borrowing money through Peer-To-Peer Lending is that poor credit having people get better interest rates. However, how is a motorcycle borderline but a boat a bad move?

  16. E says

    Hi! I’ve been a reader for a while, and have thoroughly enjoyed perusing your posts. I recently received a Prosper pre-approval letter in the mail, and I had been flirting with the idea since I opened it. I then went to your blog and searched for–and read through–all the Prosper posts, and then, I decided to sign up for an account. I’m happy to say that I got an AA rating, and am on my way to becoming a “posted listing!” I requested a small amount to consolidate debt that I had accrued in the process of purchasing real estate this past spring (luckily, the down payment/closing costs/contractor fees were all paid in full–in cash!–but all the rest of my things somehow found themselves on my cards… especially after paying the IRS a pretty penny, since they only accept cash!). I am now in the process of account verification. My question to you is: do I tell my boss (whose # I put as the employer’s main line, as we are a startup consulting firm, and she was also the one to verify my income and employment during my mortgaging process) about this? I feel slightly uncomfortable telling her that I’ve applied for a P2P loan, but how else can I tell her that she’ll be getting a call from a random # verifying that I work for her? Kindly advise. Any and all feedback and advice would be greatly appreciated!

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