Crowd Funding in Consumer Debts?

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CrowdfundingescenseCrowd funding starts getting traction for the past few years. Isn’t wonderful that people who need money for personal or business purpose can just go online and ask for money? Instead of going to bank or your friends or families, cash from the strangers flows in with just a few clicks. There are crowd funding for non for profit, start ups, charity, creative projects, potato salad, t-shirts, and personal or medical needs.

Crowd funding also provides additional channels and opportunities for investors, in addition to the traditional investments options, such as stock or bond. Since Lending Club or Prosper opened their doors in 2006, Peer to peer lending has grown rapidly. Both of these companies provide a similar offering – the ability to invest in unsecured debt, most often for credit card consolidation.

Investing for cash flow, should you be a crowd funding Investor on consumer debt, in the platform such as Lending Club or Prosper? So Far, I have not been convinced that it’s good fit for me for the purpose of investing. Here are my reasons.

1. No collateral to back up the loan.
2. Underwriting process

1. Collateral: This is one of the major differences between secured debt and unsecured debt. The most fundamental difference, I must say. Secured debt backed up by collateral like real estate. The investment is backed by the property and this is a huge plus compared to unsecured debts. When the borrower is defaulted on his payments, the property can be foreclosed on to recoup the investment. Many times, there are also personal guarantees from the borrower in the event there is still a shortfall after any foreclosure.

For unsecured debt, the only way to collect on bad debt is to go after the borrower. Apparently, when a borrower stops paying his debt, he is either unable to pay or don’t care about repay his debt at all. The chance to recoup your investment is so slim compared to secured debt.

2. Underwriting process: Secured debt is underwritten by three guidelines.
Capacity-Does the borrower has the resources and means to pay off the debts?
Credit—Does your credit history shows that you pay back your debts on time?
Collateral—Is the value of the collateral sufficient cover the debt in the event of the default? Some detailed discussion here.

For secured debts, all three items need to be verified with the proper supporting documents. You would think for unsecured debts, the credit and capacity will be verified even though there’s no collateral.

Let’s see what Lending Club prospectus on page 47 said” Borrowers supply a variety of unverified information that is included in the borrower loan listings on our website and in the posting reports and sales reports we file with the SEC for Standard Program Loans. Requested information also includes a borrower’s income or employment, which may be unverified. Procedures are in place to determine if verification is necessary.

On page 34 mentioned “Information supplied by borrowers may be inaccurate or intentionally false and should generally not be relied upon. Credit Information that we receive about a borrower may be inaccurate or may not accurately reflect the borrower’s creditworthiness, which may cause you to lose part or all of the purchase price you pay for a Note.

The bottom line is you really have no control of the quality of the borrowers. Even though the credit reports show good scores, you are not certain if the report is correct.

It seems to me that the return is not enough to compensate the risk I will be taking in consumer debt lending.

What’s your P2P lending experience?

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