Taking into account the Prosper fees and net default rates, which credit grade will have the highest return of investment (ROI)?
In order to assist you with making this decision, I have generated 2 tables using default rates originating from Experian and Prosper.com.
Update: Please note that all Prosper loans are 3-year terms and Prosper has only been around since February of 2006. This means that there is not enough data to in giving accurate default rates based on the historical performance of Prosper loans. Prosper is still young and needs to mature in order to obtain accurate statistics. Right now, we can only extrapolate and predict with the limited amount of data that we have.
| Credit grade | AA | A | B | C | D | E | HR |
|---|---|---|---|---|---|---|---|
| Average lender rate | 10.31% | 12.29% | 14.46% | 17.00% | 19.73% | 22.97% | 22.16% |
| Prosper fee | 0.5% | 0.5% | 1.0% | 1.0% | 1.0% | 1.0% | 1.0% |
| Average default rate | 0.20% | 0.90% | 1.80% | 3.30% | 6.20% | 9.10% | 13.90% |
| Average annual return | 9.61% | 10.89% | 11.66% | 12.70% | 12.53% | 12.87% | 7.29% |
The default rate is the Experian historical average by credit grade for borrowers with debt to income ratios of 20% or less. The average lender rate is derived from all Prosper loans between the dates of 6/1/2006 to 9/20/2007.
| Credit grade | AA | A | B | C | D | E | HR |
|---|---|---|---|---|---|---|---|
| Average lender rate | 10.31% | 12.29% | 14.46% | 17.00% | 19.73% | 22.97% | 22.16% |
| Prosper fee | 0.5% | 0.5% | 1.0% | 1.0% | 1.0% | 1.0% | 1.0% |
| Average default rate | 0.50% | 2.32% | 3.24% | 8.14% | 7.74% | 10.89% | 17.62% |
| Average annual return | 9.31% | 9.47% | 10.22% | 7.86% | 10.99% | 11.08% | 3.54% |
The default rate is from Prosper loans between the 6/1/2006 to 9/20/2007. The average lender rate is derived from all Prosper loans between the dates of 6/1/2006 to 9/20/2007.
According to the second table, loans from borrowers with a D or E credit rating will have the highest ROI. Please note that if you plan on bidding on these types of loans, you should always use the minimum bid and have a large portfolio (or at least plan to have one). These 2 credit grades make up the majority of my portfolio and I am currently seeing some very nice returns. Another clear message from these 2 tables is to stay clear from bidding on borrowers with an HR rating. It is extremely risky with very low returns.
One interesting note from these 2 tables is the difference in default rates. The default rates on Prosper loans is consistently higher across the board for all credit grades. After thinking about this a bit, I think that it makes a lot of sense. Borrowers who are looking for loans will usually use traditional methods such as applying for credit cards or loans from banks. Many of the Prosper listings could have been from people who were initially rejected using traditional methods so that can explain the higher default rates. Of course, I am not a professional credit analyst but that is my 2 cents.
One anomaly that you might have noticed is the spike in default rate for the C credit grade borrowers in the second table. I do not know how to explain this but it might have something to do with how Prosper assigns these credit grades.
The breakdown is as follows:
| Credit Grade | AA | A | B | C | D | E | HR |
|---|---|---|---|---|---|---|---|
| Experian Credit Score | 760 and up | 720-759 | 680-719 | 640-679 | 600-639 | 560-599 | 520-559 |
You may also be interested in reading the following posts:
- Default Rates broken down by Credit Grade and DTI Buckets
- How do I choose a Prosper loan to fund?
- What interest rate should I use when bidding on a loan?
- How much money should I bid on Prosper loans?
Thanks so much for this. Your blog is awesome.