Look For A Real Online Business? Try Online Lending

Back in 2007, I was convinced that rental real estate was the way to go!

I had put together a team. One guy, who had a few properties already, was going to accompany me through the “walk-throughs,” one guy would send me leads based on my MLS search criteria, and then another guy who did repairs and whose specialty was returning houses close to their full market value at a low cost.

All I needed was the financing. Got that through a division of Wachovia that actually had a lot of Asian clients. Anyway. So, there I was, ready to go! I also had quite a few thousand in reserve and was ready to go shopping.

If you are not aware the Philadelphia market has a unique home called a row home. (Pictured Above.) The 2 to 3 bedroom row home in and around the Philly area is very reasonably priced for an investor (well under 100k), and there were plenty on the market.

When I took a closer look at the market though, something just didn’t seem right. I decided to wait.

But, what was I going to do with some of the money I had saved up for the occasion?

Along came online lending. My first, real, online business!

Online Lending

The Federal Reserve appears to have no interest in raising their target interest rate above near zero for the immediate future, leaving interest rates on savings accounts at all-time lows. “High-Yield” savings accounts are offering interest rates as low as 1% and saving money has been an exercise in futility. As a result, investors like myself are looking to diversify their investments outside of banks and the stock market (I’ve maintained my own 100K+ stock portfolio since 2002) . Peer-to-peer lending firms such as Prosper.com and Lending Club to receive higher interest rates, but can one compare peer to peer lending with an online savings account?

Interest Rates

When considering interest rates, creating a diversified loan portfolio with Lending Club or Prosper will offer a much better rate of return than what one would receive with a high-yield savings account. Currently banks are offering interest rates between 1.0% and 2.00% APY. Lending Club investors (according to Lending Club) have averaged 9.68% APY and Prosper.com investors (according to Prosper.com) are averaging 10.01% APY.

What about Risk?

If interest rates were the only consideration, making loans to people through peer-to-peer lending institutions would win hands down, but investors also have to factor in risk. With a high-yield savings account, investor’s returns are guaranteed to them by the full faith and credit of the Federal Government through the FDIC.

By lending small amounts of money to a large number of people, your interest rate is wholly dependent upon people repaying their loans. Lending Club and Prosper have been able to minimize this risk by spreading out your investment risk to many different borrowers. Although there’s going to be a percentage of borrowers that do not repay their loan, somewhere in the 1-5% range, overall it can still be much more lucrative to loan to individuals through these peer to peer lending institutions than it is to put your money into a bank.

What about Liquidity?

With a high-yield savings account, one can withdraw their money from the bank with no penalty. With most CD’s, there is usually only a relatively small and painless penalty to take out your funds and turn them into useable cash. With Lending Club and Prosper, it’s much more like you’re investing in a certificate of deposit than with a traditional savings account where you can take the money out right away.

Typically, investors hold the loans that they make through the end of their term. Lending Club has developed an innovative solution to allow lenders to get out of their loans though. The company has partnered with FOLIOfn to develop a note trading platform that allows individuals with Lending Club accounts to buy and sell their loans.

Other Considerations

With a savings account or CD, you can deposit your money and never think about it again until you want to take it out. With Lending Club or Prosper, you have to individually choose loans or have them chosen for you with a matching system. There is definitely more leg work involved with peer-to-peer lending sites, but the extra work may be well worth the reward of much higher interest rates.

The Verdict

Services such as Lending Club and Prosper should not replace your high-yield savings account for short-term savings that may need to be liquidated within a period of a few months, but if you have some savings that you would like to invest for 3 years or longer, using sites such as Lending Club and Prosper can be a great way to get a much better rate of return on your money than through a traditional savings account or CD.

In Closing

After about 9 months with Prosper, the plug was pulled for Pennsylvania lenders. I moved my business to Delaware after that and continued to be both a Prosper lender and borrower. I would borrow at a low rate and lend at a higher rate. That’s the American Way, isn’t?  To leverage off someone else’s money, right?

Online lending is a real online business. Prosper provides tons of information for you to analyze their lending environment, risk and performance. Some businesses only do Prosper and have lending portfolio approaching a million dollars. Stop waiting on that AdSense check and do something practical for yourself.

I am now back in the market for rental real estate! I think the timing is pretty good right now. Don’t you?