Debt to Income (DTI) shenanigans.

I've been wondering what would drive a person to Peer-To-Peer (P2P) lending. Why would anyone want to take out a loan from a website like when it seems like every day the huge banks are trying desperately to loan you money in one form or another.

Big Banks Vs.

The bank I chose for comparison was Bank of America Corporation (BAC) one of the largest banks on earth. I found some data on their loan rates in this Supplemental Second Quarter 2007 Financial Information on page 9, titled "Quarterly Average Balances and Interest Rates - Fully Taxable-equivalent Basis"

  • Credit card - domestic: 12.67%
  • Other consumer: 9.28%
  • Direct/Indirect consumer: 8.46%
  • Home equity: 7.57%
  • Residential mortgage: 5.70%

    Now let's look at They have a nifty chart of loans made in the past 30 days, but I didn't think it was all that helpful as it didn't tell you amounts or give you an idea of weighted rates for comparison to Bank of America. Here it is anyhow, for your amusement.

    Instead, I found the following data on their loan performance page for June 30, 2006 - June 30, 2007.

    Average annual return
    AA: 9.13%
    A: 10.07%
    B: 10.91%
    C: 11.18%
    D: 11.65%
    E: 8.64%

    Then I thought it would be interesting to look at recent activity, so I pulled the data for June 1, 2007 - June 30, 2007 and ran a few numbers.

    Loans Originated: $2,571,711
    Number of Loans: 327
    Average loan: $7,864.56

    AA: $764,958 - 82 (Average = 9,328.76) - 29.7%
    A: $475,316 - 55 (Average = 8,642.11) - 18.5%
    B: $493,534 - 57 (Average = 8,658.49) - 19.2%
    C: $465,625 - 62 (Average = 7,510.08) - 18.1%
    D: $284,127 - 48 (Average = 5,919.31) - 11.0%
    E: $61,100 - 15 (Average = 4,073.33) - 2.4%
    HR: $27,051 - 8 (Average = 3,381.38) - 1.1%

    Using the above average returns and assuming that 100% of the HR loans will default (0% return), I got a weighted average APR of 10.19%.

    Compare this to Bank of America's average rate for a direct consumer loan of 8.46%. That's a premium of 1.73% over Bank of America's average return. What's the deal here? Why would you pay a premium to throw your life story on the internet where anyone can read it? Is it because the borrowers have low quality credit?

    Credit Quality: Fico Scores

    I wanted to see how credit quality works with FICO scores. The distribution of scores (Source) looks like this:'s credit grades (Source) look like this:

    And to be helpful with your analysis, also provides you with this nifty chart of historical defaults by credit grade. Please not something VERY important on this chart - the note that says "for borrowers with debt to income ratios of 20% or less".

    Going back to the loan data from June 2007, it appears that most of the loans are being made to high quality credit. 48.2% are going to A or beter, which are people with credit ratings of 720+. That should be a default rate of less than 0.9%, right? WRONG.

    Debt To Income (DTI)

    Let's look at what Prosper has to say about DTI.
    "What is a debt-to-income ratio?

    Part of a borrower's credit profile is a debt-to-income ratio. Debt-to-income ratio (or DTI) is a measurement of the borrower's ability to take on additional debt. This number takes into consideration how much debt the borrower had prior to their loan in addition to what their debt will be if the loan they are requesting is made. (Their debt history is part of their credit history, and is reported to Prosper in the initial credit check.) The DTI is calculated by dividing the borrower's annual income (before taxes) into their annual non-housing debt payments. It is expressed as a percentage.

    Generally a DTI of 20% is at the upper end of normal when excluding housing debt. Loans with debt-to-income ratios exceeding 20% are more risky—in some cases very risky—and much more difficult when trying to estimate default risk. In fact, whereas Prosper provides general default rate estimates when debt-to-income is 20% or lower, no estimates are provided for debt-to-income ratios greater than 20%.

    If the DTI is shown as "N/A" (not available), it may be for one of two reasons. First, it may be that Experian (Prosper's credit reporting partner) has not been able to provide a reliable number for the borrower's monthly debt burder. Second, it may be that the borrower cannot provide documented proof of income, and has stated so in his or her application.

    If you are a beginning lender or unsure of how to factor in high-risk borrowers, we recommend that you stick with borrowers who have a DTI of 20% or less."

    Looking at current loan listings that are at 100% funding meaning the loan is going to be made for sure, here's what I found for average DTI. (Ignoring loans that didn't list DTI.)

    AA: 13 loans, $128,501, weighted average 20.8%
    A: 12 loans, $98,560, weighted average 24.8%
    B: 14 loans, $105,900, weighted average 19.44%
    C: 15 loans, $107,600, weighted average 37.08%

    So MOST of these loans are being made to people that are listing their DTI at ABOVE 20%. No wonder the big banks won't give these people money. According to the the US Census, renters spent 29% of their income on housing in 2001. So say 20% is the upper guideline for DTI. 20% DTI + 29% housing = 49%. That leaves 51% for food, transportation, savings, luxury items, insurance, etc. It seems pretty iffy.

    Now look at the C grade debt at 37.08% DTI. 37.08% + 29.00% = 66.08%, leaving 33.92% for food, clothing, utilities, etc. At under 20% DTI, the C default rate is 3.30%. What do you think the default rate is above 35%?

    But it gets worse - I believe their listed DTI ratios are questionable at best.

    Information Quality:

    Check out this example. If the link is dead, you can read some excerpts here:
    "Purpose of loan:
    I want to stop my collection accounts from accruing more interest by making a settlement on the larger one, and paying in full the smaller one. As you see in my listing, my total delinquent amount is about 3600. The larger account is 3300 of that total. I recently received a settlement offer of 1300$ for that account. I used to work in the debt collection industry for Northland Group (about 1 yr) and FRS (Financial Recovery Systems, about 6 months) and I know that summer time is the hardest time for them, so I'm writing a counter offer of $700. I'm sending my correspondence by certified mail, and only accepting an offer if I receive it in writing. If they do not accept my smaller offer I will immediately make another offer slightly higher until I come to an agreement with them. I know they will NEVER offer me in writing the lowest they can accept. That's taking money out of their own pocket. I'm asking for the SMALLEST amount of a loan that I can because I don't like to borrow money anymore, but I know now is the right time to try to get my deal accepted by the collector. That's why I am asking here.

    My financial situation:
    I have around $500 in savings in a sharebuilder account, as well as some old series E savings bonds which were given to me by my grandparents as a gift, which now are valued at around $350.00. I would not want to cash them in unless I had to, but the sharebuilder account is my emergency fund.

    Monthly net income: $ 2000.00

    Monthly expenses: $
    Housing: $ 900.00
    Insurance: $ 60.00
    Car expenses: $ 90.00 (gas, oil change, filters, car is owned 100%)
    Utilities: $ (included in my rent)
    Phone, cable, internet: $ 60.00
    Food, entertainment: $ 100.00
    Clothing, household expenses $ 40.00
    Credit cards and other loans: $ 30.00 (both cards I'm currently using I pay more than double the minimum 5$)
    Other expenses: $ 65.00 (cell phone)"
    I think something might be askew in the numbers, don't you? Theoretically, he SHOULD have $655 a month of free cash, right? Obviously he doesn't, or he wouldn't be borrowing money to pay off $3600 in defaulted credit cards. For example, I strongly question the food expense of $100. Food stamps are $155 a month for a single individual and that's supposedly hardly adequate. Yet somehow he's able to live on $3.29 a day?

    More importantly, he lists a DTI of 2%. Even if he only needs to pay $30 a month towards the two cards - what about the cell phone? Isn't that an open account at $65 a month? What about the phone line? The internet? The cable? Something isn't right here.


    While it's a lovely idea to want to help people with their problems AND make money doing it - clearly there is a reason that these people have to go to to get the loans. They are already loaded to the gills with debt and shouldn't get anymore. Further, since you can't possibly predict the actual default risk - since the information is flawed at best, you can't figure out what your required return needs to be.