I discovered peer-to-peer lending with Prosper.com in October last year and I quickly became fascinated with the whole concept. After some initial learning curve and paper bidding, I took the leap and invested $1,000 in 20 loans of $50 each. I am happy to report that all my loans are still going smoothly.

By reinvesting the profits, I now have 22 loans at an average interest rate of 14.99%. All of these loans have been current with their payments so far. Time will tell whether my success is just “dumb luck” or the method by which these loans were selected has some long-term merit.

In this series of posts, I’ll be sharing with you the method I’ve developed for selecting loans. The reason being is two fold: one is to give back to the Prosper community that has helped me learn the ropes, and secondly, to improve the method through public peer review for everyone’s benefit.

In evaluating loan candidates, I have two sets of criteria: those that I have Prosper filter out automatically, and others that I look at manually for a hands-on determination. For the first set, I use Prosper’s Advanced Search criteria to weed through all the chaff. I then apply the second set of selection criteria to each interesting loan candidate in the search results.

Finding the Advanced Search Page

In this first post, we’ll be looking at the set of Advanced Search criteria used. For starters, just getting to the Advanced Search page is a bit cumbersome. To get there, you’ll first need to click on the “Bid on Loans” tab at the top of the page. On the loan listing page that follows, look on the left-hand side for the “Search Loans” box. Click on the “Advanced” link inside this box next to the orange Search button.

The 11 Search Criteria

The first thing you’ll want to do upon landing on the search page is to pick the criteria for your search. You do this by clicking on the “Add/remove criteria” link at the top-left of the page. When you click that link, a window will come up to select a few dozen different criterion.

Below is the list of criterion that I select from this window:

1. Now delinquent. If the person has a history of late payments, especially ones that are late right now, that’s enough to raise the red flag for me. I’m not interested in even looking at loan requests from people who’ve already demonstrated they don’t place a priority on paying back their obligations in a timely manner. I choose “0″ to “0″ on this criterion.
2. Delinquencies in last 7 years. I choose “0″ to “1″ here. I allow for 1 delinquency so I don’t unnecessarily filter out those that were due to some clerical error. For example, the borrower may have moved and a bill was sent to the old address, or even some creditor reporting someone else’s late payment to the borrower’s credit report by mistake. If they do have a delinquency, there better be a very good reason for me to discount it.
3. Public records in last 12 months. Again here, I have no interest in loaning money to people who have demonstrated they have no sense of obligation to repay their debts. Bankruptcies need not apply. I enter “0″ to “0″ here.
4. Public records in last 10 years. Here also, I choose “0″ to “0″. Filing for bankruptcy to me is an indicator of personal character. A person’s inherent personality traits are tough to change. Given that I don’t know the borrower well enough to gauge whether the lesson has been learned, I’d rather just pass on the loan.
5. Automatic funding. This feature in Prosper closes the loan as soon as it reaches 100% funding. This means that bidding doesn’t continue to potentially lower the interest rate to the borrower’s benefit. Borrowers that forgo this benefit raise a yellow flag for me. Automatic funding could imply that the borrower needs the money too desperately or in the worst case, that s/he has no intention of paying the money back, and hence, the interest rate really doesn’t matter. Neither may be true for a particular borrower, but since I’m dealing with a stranger, I’ll pass on the risk. I choose “Exclude” here.
6. Employment status. The only ones I uncheck here are “Not Employed” and “Not Available”. If the borrower doesn’t have the means to repay the loan or wishes to conceal this information, either is enough to scare me away.
7. Total Prosper loans. Borrowers with good payment histories on their credit reports are great. Borrowers with a track record of repaying Prosper.com loans in particular are even better. These borrowers have demonstrated they care about their reputation on Prosper enough to honor their obligations. I enter 1 to 999 here.
8. On-time payments billed. Related to the delinquencies above, people who are late on their Prosper loans is not a good sign. I enter 100% to 100% here.
9. Total payments billed. This is the number of payments a borrower has made on a prior (or active) Prosper loan. I like to see a history of at least 9 months here, so I enter 9 to 999.
10. Credit grades and minimum rates. I only exclude the HR credit rating, if I remember to do anything here. The other criteria above weed out a lot of bad borrowers out of the gate, so I don’t concern myself too much with the credit grade. Some people may argue that there are higher default rates on average for the lower credit grades, and hence more inherent risk. Although this is true, I believe the majority of the borrowers that default in the lower grades would fail to meet one of the criteria above or fail one or more criteria in the second set. Due diligence goes a long way toward mitigating default risk.
11. % Funded. I don’t want to waste my time researching loans and tying up my money on them for over a week just to find out they didn’t get funded. I focus my time on those that have the best chances of getting funded. I enter 90% to 100% for this criterion.

You can optionally omit criteria 7 - 9 if there’s not currently any loan candidates from borrowers with prior Prosper.com track records. In my experience though, you can usually just repeat your search a couple days later and a qualifying loan will show up.

Prioritizing the Search Results

Before htting the Search button on the above criteria, first choose some sorting options so you can focus in on loans that (a) other lenders already have confidence in and (b) are ending soon so that your money is tied up for the least amount of time before the bidding closes. To accomplish both these goals, sort by descending “% Funded”, then by ascending “Time left” in the Search page’s Sort Order box.

Next Steps

Once the search results are displayed, all that’s left to do is evalute each candidate loan against a second set of criteria. The second set contains criteria that can either not be automated (such as an income/expense analysis or gauging the borrower’s credibility for why the loan is needed), or those criteria that could be more or less important given the total picture of all loan factors.

I’ll be covering the second set of criteria in the next post of this series, but in the meantime feel free to sound off in the comments section with any other criteria you’ve used with good success.

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