Like many Americans, Im in debt. Serious debt. I owe more money than I make in a year.
With the federal government operating at $8.6 trillion in debt, and with American consumers owing nearly $2 trillion more than the gross national product of many industrialized nations to credit card companies and other creditors, some might say that debt is the American way.
My debt is so scary that Ive largely ignored it, unable to deal. Ive contended with multiple daily messages about an important business matter, but otherwise, not facing it has been a fairly easy way of managing it. I cant get a mortgage with an interest rate short of robbery, and even credit card companies have shunned me, so I get by paycheck-to-paycheck, trying not to increase my debt.
Ignore it and itll go away, however, is not a long-term operating principle. I was unemployed for much of 2006 and discovered that many employers now run credit checks on potential employees, as do landlords. My credit report can affect my housing and employment, and I had no idea what the report even said. It frustrated me that my secret past of fiscal irresponsibility was used to judge me, ultimately keeping me back.
So I set out to face the monster. I went to TrueCredit.com and bought my credit reports for $29. Beer in hand, I saw myself as the credit world sees me.
As a student, I took out the largest loan allowed each semester, for tuition and living expenses, sure, but also for stereos and other items not directly related to my education. My student loan account is now horribly delinquent, weeks away from defaulting. The credit cards are already in default. Library fines and parking tickets have been sold to collectors. I also have bounced checks from now-closed accounts and am years removed from a host of other small financial missteps.
After figuring out which accounts need to be paid now and making deals with others, I arrived at the amount needed to bring me current and on the road to better credit: $1,700. Not bad! Problem is, Ive dug a hole so deep no one will risk helping me out, and I have no savings to halt that number from doubling. No credit card will give me a $1,700 line of credit, and when I applied for a loan through my local bank, I was told, Itll be difficult for you to do anything.
I could go to predatory lenders, like a payday-loan agency or high-risk lenders disguised as credit counselors, but with payday loans in Colorado at an average 345 annual percentage rate (APR), I could dig myself deeper. Simply put, I have no access to credit. All reasonable creditors see me as a number. They dont look beyond and see the human desperately trying to make good and right the wrongs.
Some years back, Chris Larsen had a sleazy mortgage experience that left him feeling ripped off, with the impression that the credit system in America is corrupt and generally mucked up. He set out to change things by starting eLoan, an online mortgage, home equity and car-loan lender. eLoan was a success, doing more than $27 billion in business over the Internet. But Larsen dreamt of further democratizing lending.
We started thinking with the eLoan experience, Well, what would be the ultimate model here? and kept coming back to an eBay for money, he says. eBay has been so great at democratizing. Theyre bringing capitalism to the masses.
Last year, Larsen sold eLoan for $300 million, and he launched Prosper.com in February. Today, Prosper has more than 100,000 members with $23 million in loans.
Prospers framework combines the peer-to-peer marketplace of eBay with the social networking of MySpace. Borrowers seeking between $1,000 and $25,000 post profiles explaining their need for a loan, and lenders bid on the most attractive loans the same way eBay users bid for products except the lowest interest rates, not the highest offers, win.
Most loans are funded by dozens of lenders who bid $50 each, the minimum allowed. Prosper keeps a 1 percent loan-originating fee (a one-time $25 charge for a $1,000 loan), and bills the lender a 0.5 percent annual loan-servicing charge. Borrowers have three years to pay off the debt, with no penalty for pre-payment. Basically, Prosper is a peer-to-peer lending auction with a human element.
One of Larsens missions at eLoan was to be radically pro-consumer, and hes brought that ideal to Prosper. In most lending situations, the borrower approaches the lender, putting the lender in a position of power. Prosper turns that model on its head. Here, the lenders seek out the borrowers, who set the details of their loan, including a cap on the interest rate theyre willing or able to pay.
Larsen calls this libertarian paternalism. Anyone who can clear an identity check can post a listing. And any American with $50 can bid on that listing. Lenders can assess their risk using methods such as credit ratings based on a borrowers actual credit score. And the borrowers debt-to-income ratio marked with a red warning label if the ratio is high cautions lenders against those who may not be able to afford the loan. From that point, the market is open to do what it will. Prosper is merely the tool, the venue.
As a result, the diversity of borrowers on Prosper is impressive. There are the entrepreneurs seeking start-up capital; those seeking car loans at lower interest rates and more manageable payment schedules than offered by dealers; and the people with terrible credit history trying to get a fresh start.
A quick survey of the site reveals some compelling stories. One single mother, an Iraq war veteran, is trying to consolidate her debt in order to get back on her feet. Shes posted pictures with her children and lays out her monthly budget for all to see.
A professional woman recently diagnosed with cancer needs $25,000 to front her chemo treatment until the health-insurance paperwork is processed.
Many of the borrowers are people who, for numerous reasons, are not able to get credit elsewhere, and many of these people find loans on Prosper. Tales of funding someone with such dire needs can warm the heart, but Larsen is quick to clarify that Prosper is not an altruistic endeavor.
Were a for-profit company, he says. If were ever really going to take on this trillion-dollar credit market, just for unsecured credit alone, there really needs to be a model that can sustain itself, not just through charitable contributions, but through good returns on investment.
We believe, much like the eBay sort of mission, that most people are good, and if people are given open access to trade, good things will come. You could probably track all the evils of predatory lenders, payday lenders, all the bad stuff that happens in credit, back to lack of transparency, lack of access.
Some have compared Larsen to Ralph Nader for his consumer-rights fervor. In California, where Prosper is based, Larsen put up $1 million for petitioning and acted as a mediator between legislators and financial institutions to pass a law that prevents the buying and selling of financial information without notifying the consumer, a practice Larsen says contributes to the proliferation of identity theft. Hes also worked to create greater consumer access to credit information, which was highly guarded by the industry until 2001.
Consumers need to be on an equal playing field with lenders who have that information, Larsen says. He uses the example of an auto dealer to illustrate his point.
Just when youre at your lowest low, he gives you a rate thats probably five or six points higher than what you really should be getting. Then hes turning around and selling it to Wall Street at the real price, and hes making a killing. That can only happen when theres lack of access. Can anybody else see that transaction in America? Does anybody else see what it actually sold for on the capital markets?
As much as they run the risk of getting screwed by traditional loans, solo borrowers on Prosper, especially those viewed as higher-risk by lenders, have a harder time getting a loan. For them, there are Prosper groups. Apple User Group, Independent Filmmakers, Funding Your Wedding, Corporate Divas, Minorities in Need of Money, Christian Opportunities theres a group to suit every user.
Groups primarily act as social networks. Users apply to a group, and the group leader accepts or denies the application. Some group leaders require a meeting or phone call, a bank statement or full financial vetting. The best groups are the most difficult to join.
Good group leaders act as mentors, reviewing member listings before theyre posted and offering advice. Lenders will reference a groups rating and its members repayment histories when considering a loan. Groups essentially vouch for their members, and a members poor repayment history affects the whole group. Prosper kicks back some cash to group leaders whose members pay on time, and the leader can choose to share it with the group or keep it as compensation. Many members make money as they repay their loans.
More importantly, groups introduce what Larsen calls the shame factor. Group members feel compelled to repay their loans to avoid the shame of letting their group down.
How will you be looked at in your community if you do not repay your debt? asks Larsen. Thats something that Americas sort of lost.
Prosper, upon first glance, may seem like a new idea, but its not. Larsen references the classic holiday film Its a Wonderful Life.
Back then, with small community banks, borrowed money was actually a neighbors money. Prosper simply cuts out the middleman. While the neighbor may be earning 3 percent interest on his $5,000 savings deposit, the borrower is paying 19 percent interest on her line of credit from the same bank, for the same amount. Meet in the middle at 11 percent on Prosper, and she pays eight points less while he makes eight points more a win-win.
If a lender were truly a neighbor, the borrower would feel more inclined to pay on time, to save embarrassing encounters at the curb while putting out the garbage. This shame factor is lost when dealing with a large, faceless institution. With Prosper groups, borrowers are accountable to real people. But this is not an innovative concept.
Prosper was partially built on a Vietnamese system called hui, Larsen says. Its a system of peer-to-peer lending, where a small village will get together; 12 people participate, six will be lenders and six will be borrowers. And it works very strongly on that sense of accountability for the community.
Whats missing here is a lenders ability to diversify. Rather than lending $5,000 to an individual at 20 percent, lend $50 to 100 people with the same interest rate. Should one of them default, the rest will cover the loss. In many cultures, community members lend and borrow among themselves. Rotating savings and credit associations (ROSCAs) are an example, and Prosper is a kind of American version.
What Larsen calls the shame factor, Muhammad Yunus calls solidarity. Yunus pioneered microcredit, a system of giving small loans to those who otherwise would not have access to credit. He, along with his Grameen Bank, won the Nobel Peace Prize this year for fighting poverty using the method. Yunus believes credit is a basic human right.
The United Nations declared 2005 the International Year of Microcredit. Microcredit generally works with philanthropists making guarantees, dollar amounts not donated but placed as collateral should loans default. The guarantee remains in an investment account while microfinance institutions (MFIs) use it to back small loans to the worlds poor and extreme poor, who have no access to credit or banking of any sort.
Conventional wisdom would say loaning money to the poor and extreme poor is not good for lender or borrower, but Yunus has proven differently. A small loan of less than $500 is often all thats needed to lift the poor out of poverty. Of those whove remained in Yunus program for more than five years, more than 50 percent have pulled themselves out of poverty, he says.
Yunus work also shows that the poor tend to make natural entrepreneurs. Their fight for survival has taught them efficiency, frugality and creativity in getting the most out of their money. With a small loan, a person can buy a goat to breed and sell the offspring, or start another business. And, perhaps most surprisingly, the available numbers show that the poor are fiscally responsible.
Well-run MFIs typically have a default rate of less than 2 percent, says Kyle Sayler, senior vice president of portfolio management for MicroCredit Enterprises. And while industry-wide numbers are not available, he suspects the average repayment rate is somewhere around 96 percent. Repayment rates are better than in traditional banking in the U.S.
MicroCredit Enterprises is a relatively new organization whose employees work mostly pro bono to raise money for MFIs within communities. Like many MFIs, MicroCredit prefers to work with women. And 96 percent of Grameen Banks loans are awarded to groups of women.
Some would say women tend to repay better. I dont know if thats the case or not, Sayler says. In our case, when women increase the income in their families, theyll take a greater share and put it toward food or clothes or education for their children.
Sayler spent two years running an MFI in Chiapas, Mexico, and says one factor that contributes to high repayment rates on microcredit loans is the willingness of group members to cover a payment for another member when she cannot.
It worked because they came from the same community, and they self-selected their group, he says. We didnt force anyone to work with anyone they didnt want to.
As MFIs prove that the worlds extreme poor are responsible borrowers, the giant, for-profit banks are eyeing a slice of the pie.
I think theres a big divide in the industry right now between fear of commercialization and pushing commercialization, Sayler says. Theres a little bit that makes me fear making money on the backs of the poor. But at the same time, I think [commercialization] causes MFIs to operate more efficiently. Increase in competition and efficiency pushes down interest rates to the poor.
After all, those receiving microcredit through MFIs or Prosper all have the same goal: profit.
Livelong and ...
Andy Mowery is a Fort Collins entrepreneur and leader of the Prosper group An Entrepreneur For Sure!
We look for serious entrepreneurs, he says of the group. If they dont have a written business plan, they have a concrete idea of what they want to do with the loan.
Mowery began selling home, garden and pet supplies on eBay in 1999. Today, his company, Debnroo, has grown into a 2,500-square-foot warehouse in Fort Collins, and he expects to do about $1.1 million in retail sales this year. Revenue doesnt always mean ready capital, however, and so when he needs cash in hand, he turns to Prosper.
We most recently took out a $25,000 Prosper loan to buy a container of a product that weve been selling for over four years, and it was a single opportunity to get the item at a deep discount.
A single opportunity, Mowery says, that needed to happen in 72 hours. He found an investor to float him the capital for two weeks while he waited for a Prosper loan.
Fourteen days is not a lot of time. Id challenge anybody to try and do that with a bank, he says. I think the process through traditional banks is antiquated.
Mowery got the loan through Prosper, and he now uses his know-how to mentor others in getting loans.
James Carothers had maxed his credit and needed to clean it up before applying for a Small Business Association loan to purchase the Moose Creek Caf in Walden. He joined the group Business Loans for Entrepreneurs!, and with no mentoring, Carothers received a $5,000 loan from 26 lenders, most of whom put up the $50 minimum.
Carothers had a middle-of-the-road credit rating at the time he got his loan, with a debt-to-income ratio of 17 percent not low. His groups track record and his personal listing which noted a financially crippling car accident 13 years prior, his Christian faith and his post on the town council brought skeptical lenders to his side.
I had it funded in less than four hours, he says. I hope to leverage myself in the next six months into a position where, rather than a borrower, Ill become a lender to help other people out.
While Prosper lenders certainly look for attractive returns, those who post listings that appeal to emotions and present a human face get funded. Apparently, lenders like to think they are helping out.
Youve got to be able to communicate to people that theres a human being behind the screen name and tie in emotional aspects, Mowery says. Emotion works. Thats part of what marketing and salesmanship is all about.
My first loan application on Prosper, for $1,000, was a terrible failure. My credit rating lists me as high-risk, though my debt-to-income ratio is the lowest possible at 1 percent. Colorado caps interest rates at 21 percent, and most lenders dont see that as a high enough risk-to-return ratio.
Immediately after I posted my listing, I received multiple messages from well-intentioned users offering suggestions. I was told to detail my four current defaults, vet my personal finances and, please God, join a group already.
So I joined the first group I found, one with 910 members who I knew would accept my poor-credit self. Its obnoxious name More loans FUNDED @ LOWER % than ANY other group gave me hope.
So I posted for another loan, now backed by what I thought was a successful group.
I got messages from the same people who replied after I posted my first loan. I was scolded: Have you learned nothing since your last listing? Apparently, lenders shun my group. They say the group leader cant hold 910 people accountable and offers no mentoring. And I never heard from the group leader.
I soon withdrew my second loan application.
In order for Prosper to work for me, I must do more homework. I need to scour the message boards for comments about groups and join one thats right for me. I need to post a transparent profile that explains in detail why Im in this situation and how I plan to budget payments. I need to build lender confidence.
But in the back of my mind, I wonder, If I get this loan, will I make payments on time, or will I fall back into old habits? Prosper gives credit to those who cant get it elsewhere, but if I fail to uphold my end of the deal, Ill be sent to collection agencies. Yet if I make payments regularly, its positively reflected on my credit report.
Sometimes credit is something that completely turns around somebodys life; they could start a business, says Larsen. And sometimes credit for a person at the wrong time in their life can actually be detrimental. Im looking to the worlds poor for an example.
Josh Johnson is a former contributor to the Colorado Springs Independent and current associate publisher at the Rocky Mountain Chronicle, where this story originally appeared.