Establishing a self-sustaining Prosper loan ladder

Well, it's official. I've gotten the $1500 Prosper loan applied to my account, and I've managed to deploy about $900 of it so far on bids. Time will tell how many of them become winning bids, but for now, my screening criteria seems to be providing me with at least a few quality loans to bid on.

Right now, everyone is getting a bid of $50. This is going to be the default amount bid until I reach a point where I can't find enough loans to bid on for all of the income that is coming in from payments. I'm thinking I'll probably have a flurry of bids for the next two or three months until I get all of the money into play, and then it will settle down back to one or two bids per month again. The other consequence of bidding as much as I am now is that my average rate of return will probably drop. On the other hand, my risk adjusted rate of return will most likely rise, as I am now able to bid on a slightly more diverse range of credit grades. For example, I would bid on a "C" credit grade all the way down to 15%...but I'll probably get the loan at around 20%. That gives me a risk adjusted rate of 16%...4% more than my required minimum, and approximately 8% higher than the loan I took out from Prosper to re-lend.

I'd consider that to be pretty damn good. :-)

How to deal with a pay raise

I know I've read an article with the same title of this post on MSN Money, but who cares. I'm going to cover the topic here, because I just found out that I am getting a $136 per month bump in my Basic Allowance for Housing next year! Whoo-hoo!

For those of you unfamiliar with the military, our pay is taxable, but our allowances (BAS and BAH) are not. In other words, this money represents an ACTUAL $136 raise in pay, versus a before tax raise like a COLA (cost of living adjustment) raise.

The reason that BAH went up here at Tyndall AFB is because rents and utility costs increased pretty dramatically in this area last year. As a homeowner, however, I am partially insulated from this phenomenon. My homeowner's exemption kicked in finally, so my monthly required mortgage payment actually WENT DOWN. :-D This had no effect on my monthly budget, other than to increase the amount of additional principle that I am paying towards my mortgage. I am on a bi-weekly payment program that I have set up where I send exactly $450 every two weeks. Since my mortgage required payment actually decreased, the additional amount applied towards principle will increase from $87.78 to $119.97.

With the additional $136 coming in...I've decided that I am going to bump up all of my savings pots, and try to stick to my stated goal of keeping expenses the same.

So, I'll divvy it up like this:
$25 - credit card principle payment increase
$18 - emergency fund
$20 - car principle payment increase
$13 - retirement savings increase
$60 - COLA adjustment.

See, I figure that I have to keep at least SOME of it, in order to offset the rise in prices that neccesitated this increase in the first place...maybe give me a little more elbow room from month to month...but my primary objectives haven't changed. Ridding myself of this debt load and saving money for retirement are my biggest goals...and nothing will give me the peace of mind and "elbow room" that paying off my debts will.

Once the credit cards and the car is paid for, that's going to be roughly $830 per month that is freed up for reallocation towards either spending, savings or going after the mortgage. At that point, I probably won't want to aggressively pursue the mortgage...I expect interest rates for savings accounts like ING will continue to rise and at 5.875%, I'm barely paying anything in the way of interest costs...but at least I'll have the OPTION. It wouldn't make sense to pay extra on towards the house if I can get a better rate of return in my savings account, you know? *sigh* I'm really looking forward to having those kinds of options.

Anyway...long story short...when you get a pay raise...don't just figure out ways to increase your lifestyle...figure out a way to save a portion of it, and with whatever is left over, THEN increase your lifestyle. Always pay yourself first.

Opportunity Cost (Part 2)

I've been thinking a bit more about my last post, and I think I should qualify some of what I was saying with regards to the interest rate I am willing to accept.

There are some people out there that are on Prosper with the primary goal of helping people achieve their financial goals. If they achieve a decent interest rate on their money in the process, then they consider that a bonus.

I share this goal, but I don't rank it with the same priority. For me, achieving a risk adjusted interest rate of greater than 11% is the higher priority. And the reason that I don't feel bad about this is because there are an unlimited number of loans to bid on.

Think about it. There are thousands of loan requests out there right now on Prosper. Hundreds more are added every day. From these multitudes, I use screening criteria that I have established to whittle down the pile of thousands to a mere two dozen or so. I am then able to read these requests, and pick from them the ones that I wish to bid on at an interest rate I consider "fair". If I am subsequently underbid by someone else then I move on to the next request. The person I was bidding on has achieved a lower interest rate that would not be considered unfair to those lending the money, and someone else who ALSO has a need gets the benefit of my funds to work with.

This does create more work for me. I have to spend more time reading requests and placing bids if/when I get underbid. The thing is...it's business. You can't "fall in love" with a particular requester. You have to do the math and make a judgement call. Much like doctors in combat, you have to perform triage, and separate those that need your help (funding), those that can survive on their own (funded but lower than my interest rate floor) and those that have no chance of survival (the multitudes that don't get bid on).

So you see, I don't feel bad for getting a high interest rate on my money. The borrower said that they were willing to accept a high interest rate, the market determined what that interest rate will be, and they either get funded or they don't. Either way, I still feel like I am helping people, because there are MANY more borrowers than there are lenders with funds to bid. My bidding helps the overall process.

Comments?

Goals and Opportunity Cost

Okay. Thanks to TiredButHappy, it has come to my attention that what I am doing may (in fact) be slightly wrong.

Here is my take on Prosper, as a whole. I view Prosper as a chance to earn a specific rate of return on my money with less risk than the stock market. Every stock market investor (and I definately consider myself one of those, even if my portfolio is miniscule) is looking for returns that beat the market average over the long term BECAUSE a 1% or 2% difference in rate of return compounded over 30 or 40 years REALLY adds up. So, basically, I have set up my Prosper screening criteria so that I can earn a minimum risk adjusted rate of 12% or higher on my money.

If I don't do that, then I might as well put my money into an index fund and take my chances with that. The opportunity cost of doing business on Prosper would be too high. Anyone who has taken Economics in college might know what I'm talking about here, but for those that didn't (or don't remember) it works like this.

Given: You have a limited amount of resources (funds) available.
Given: You have nearly unlimited ways to use those resources.
Cost: Whatever you choose to spend your resources on is the COST of doing business.
Opportunity Cost: The DIFFERENCE between what you actually spend your resources on, and what you COULD have spent your resources on.

So....every month, I get a paycheck, and I choose to spend it on paying off bills, buying food, providing shelter for myself, etc, etc....and with whatever is left over, after I have tried to save something for the future, I have the choice of what to buy with my "spending cash".

I have chosen to allocate $50 per month to Prosper, because I think there is a chance that eventually, the interest earnings from Prosper could be enough to supplement or replace my current income. Much like someone investing in stocks, bonds, a savings account, or other retirement vehicle, I view Prosper as a chance to one day escape the rat race.

That being said, I don't want to be a "parasite" on society like the payday lenders out there that prey on people charging usurious rates. I simply want to beat the market average...otherwise, I am incurring an opportunity cost.

Now, I could just lend to people like myself at rates of 15% or so and beat the market...but I think that my screening criteria will allow me to do better than that, AND help some people get out from under payday loan rates of 30-80%. If someone out there has a payday loan on their back at 50% interest, as well as 3 or 4 maxed out credit cards at 29% interest and I am willing to lend them money at 24% interest, then they are right to jump on that offer.

I got into this because my friend Ray was in that situation. He didn't want to declare bankruptcy after his divorce...but he was buried under $45,000 in credit card debt that his wife and he had accumulated during their marriage and he was being charged 29.99% APR on all of it. He only makes $42,000 per year. After paying his rent, utilities, food and car note, he wasn't left with enough money to make all of the minimum payments. Adding child support on top of all of that meant that every month, someone wasn't getting paid, and his credit was getting worse and worse, while his balances were never dropping because late payment fees and finance charges were buring him.

Finally, he was able to consolidate it all into one payment of $700 per month. It's still a lot, but at least he doesn't have to work 2 jobs now to make it, and it will all be paid off in just 4 years.

So, by lending to people like Ray...high character people that are doing their best to pay their bills and get back on their feet, I feel like I am helping their lives a little easier. They, in turn, are helping me accumulate enough money to one day retire. It's a win-win situation. For 3 years, they pay me interest, and at the end of that 3 years, they are better off financially, and so am I.

Just my thoughts....

I welcome feedback.
~Scott