How I Became a Little-Guy Lender

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Although borrowers and lenders use noms de Internet, there's a bit more due diligence than with eBay. Borrowers allow Prosper to pull credit reports (it assigns each a grade of AA to HR, for high risk, and requires a credit score of at least 520) and verify banking, employment, and homeownership. Lenders see details culled from these anonymous reports, such as debt-to-income ratios and prior defaults.

There are risks, to be sure. The biggest is defaults. Prosper's average net default rate—based on the amount of money that is defaulted after collections—from Nov. 1, 2005, through Apr. 18, 2008, for all credit grades was 4%. That's roughly in line with defaults on credit cards. For high-rated loans, net defaults were below 2%—0.5% for AA, 1.4% for A, and 1.8% for B. The default rate based on the number of loans made was somewhat higher than those net dollar figures: 6.9% overall, with high-rated loans still below 2%.

Of course, past defaults may not have any relationship to future ones. And my handpicked portfolio might do worse than average. Moreover, some lenders grouse that stated default rates don't represent the true risk, given the short time many of Prosper's loans have been on the books.

The second potential problem is liquidity. Prosper loans have three-year terms. While a borrower can repay early with no penalty, a lender can't call a loan in. Prosper is working with regulators to set up a secondary market, but for now there's no resale option.

Comfort Zone

My first loan was to a bakery in Texas, and I got to feel like an angel investor for $100. After a little obsessive Googling of the borrower's Prosper user name, I found a blog where the owners were blabbing about their problems and all the things they'd done wrong. If I'd seen it before bidding, I would have steered clear. Thankfully they paid me back in full a month later.

As I got more comfortable lending, I ponied up until I hit $1,500, an amount large enough for diversification but small enough that if something went wrong I wouldn't be sunk. I've now lent to students scraping together tuition, families consolidating credit-card debts, entrepreneurs expanding, people hit by major medical costs, and a guy buying an engagement ring. To keep risks down, I've targeted borrowers rated AA, A, and B, kept my loans in the $50 to $100 range, and forced myself to ignore incessant e-mails Prosper sends when you're outbid on a loan. I often ask borrowers for additional information.

In April, one of my 27 loans paid late, but the situation was rectified within days. Then, on Apr. 7, Prosper's chief rival, Lending Club, stopped allowing new lenders to register and existing ones to make new loans. It noted in a statement that it had "started a process to register, with the appropriate securities authorities, promissory notes that may be offered and sold to lenders through our site in the future." Most promissory notes must be registered with the Securities & Exchange Commission and the states in which they're sold, unless they qualify for an exemption. Peer-to-peer lending is so new that regulatory requirements aren't entirely clear, but a Prosper spokesperson said the company believed it was in compliance with all regulations. Prosper filed a registration statement for its secondary market with the SEC in October.

So far, as long as you discount the hours it has taken to set up my mini-portfolio, I'm doing O.K. In fact, these days, Prosper is one of the few bright spots in my portfolio. As of mid-April, my average interest rate was 13.65%, and all my loans were current on their payments. I seemed, at last, to have things running on autopilot, so I no longer need to log on every day, scroll through listings, and bid. If the loans keep paying, it might—just might—be worth it for more than the satisfaction of lending a helping hand.

Amy Feldman is a freelance writer and editor covering topics ranging from personal finance to tax policy.