Lazy Man and Money

Reader Question: Which Loan Should I Pay First?

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I got a question from a reader recently and when I tried to e-mail her back the email bounced back to me. Seems pretty odd because it was persons full name at a very well-known company. It was a well thought-out question and I hate to leave it unanswered, so I figured I’d make a post of it. I hope she’s ready. I’ll give her my typical code name of Buffy Summers and change around the loan numbers a bit to protect her identity.

I have a loan situation that I need some advice on. I have been struggling with the best way to pay off 4 loans with the same interest rate. I want to pay these off in whatever order will have the least interest paid overall. I can’t seem to find any information through researching on the web as to the best solution for this (and I’m not much of a finance person either!) The monthly payment for these 4 loans is lumped together at $373 per month. I’d like to pay an additional $300 per month, but don’t know if I should apply this extra money "strategically" across the four loans or only to one. Does it make sense to pay the highest loan first so that I can tackle the interest portion of each payment earlier rather then later? I have been using this loan comparison calculator and after playing around with different numbers, it seems like it makes most sense to pay across all four:

Here are the loan amounts:

Current Interest rate on ALL four: 6.75%
Number of payments left: 197

Loan A: $6,000
Loan B: $8,000
Loan C: $11,000
Loan D: $19,000

Here are the different payment scenarios when applying an extra $300 (as I am understanding it):

Scenario #1: Apply extra $300 to lowest loan first
If I did this, I could pay off Loan A in 1 year, 7 months, with total interest paid of $327. I can apply the extra minimum payment towards the other loans, plus roll over the extra $300.

Scenario #2: Apply extra $300 to highest loan first
If I did this, I could pay off Loan D in 4 years, paying a total of $2,323.79 in interest (just for that loan, this doesn’t include the interest on the other 3). Again, this would leave me the extra minimum payment I had been paying towards Loan D, plus I can roll-over the extra $300 at that point to the remaining 3 loans. How can I figure out the total interest paid over the life of all 4 loans this way though? I need a calculator like the one I am using that ALSO lists the amortization schedule?

Scenario #3: Apply extra $300 equally across all 4 loans
4 extra payments of $75 are applied to each loan. This would be $11,947 in interest paid over the life of the loans. However, the smaller loans would obviously be paid off sooner, meaning I could just roll over that money to the other loans (and I am assuming this would lower the amount of interest even further). Is there an easy way to calculate this?

Scenario #4 (what I have been doing for the past 2 months)
Apply extra $300 across all four loans based on percent of each individual loan amount I make the following extra payments towards each loan:

Loan A: $40
Loan B: $55
Loan C: $75
Loan D: $130

When doing it this way, I pay $11,474 extra in interest over the life of these loans.

Am I doing these calculations correctly? How should I best apply this extra $300 each month so that I pay the LEAST amount in interest over the life of all these loans? I read alot about how its better to pay the lowest loan first because it’s "psychologically" better. However, I don’t care about the psychological aspect of paying these loans off, I care about paying the least amount of interest over time.

Here are my thoughts:

It mathematically shouldn’t matter if all loans are the same interest rate. Buffy should end up paying the same interest. I put the emphasis on shouldn’t because my math isn’t what it used to be. Also, I was too lazy to find a loan amortization calculator to hand her, but there should be some good ones at Dinky Town.

However, I can see some factors that Buffy should consider:

She mentioned the “current” interest rate on all loans is 6.75%. Are they locked into that rate for the length of the loans? If not, perhaps she can anticipate which might increase in the future and pay those off first?

I’m with her on the psychological aspect of paying off loans. In the end, she knows she’s got $X in debt to pay, so getting rid of it the fastest is best. Sorry Dave Ramsey!

Readers, can you let me know what else I missed? Also, please feel free to contact me with questions any time using the contact button at the top of the page.

What Happened to Prosper on Lazy Man?

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Last week, Get Rich Slick asked the question, What Happened To All The Prosper.com Blogs? Two years ago, along with RateLadder, I probably wrote about Prosper more than most personal finance bloggers. So when RichSlick asks why the blogs have seemingly gone silent, I feel that I should stand up and answer.

Here are the 2 main reasons I think bloggers (myself included) aren’t writing about Prosper as much any more:

  • It’s Getting Old – Peer-to-peer lending was a new asset class for the average investor. I think any time a new asset class comes around, people are going to want to write about it, dissect it, and analyze it. That’s been done over and over the last two years. Is there a new angle to write about? I’m out of things to write about unless they add new features like bidding though the API (something announced at the last Prosper Days, and I’m not sure if it’s being used by anyone or not).
  • The Returns Aren’t Where I Thought They Be. When Prosper came out, I used the Experian default as my main guideline. It seems that Prosper loans default a lot more often. I don’t know if I was just not informed enough to realize that differences between the Experian data and the loans I chose to participate in. For instance, I know that the Experian data applies to debt-to-income ratios under 20%, but at the time I figured that 25% wasn’t too much different. And I didn’t look at other information like delinquencies as I didn’t know how to process it. I basically made the mistake that a lot of mortgage lenders did – I took on too much risk. Unfortunately, I wasn’t a lending professional and the government won’t bail me out.

Here are some other comments I wanted to get in, while on this topic:

  • Tricky Math – The next day after asking the question, Get Rich Slick Fishes Through LendingStats To Learn About Prosper. He takes the top 10 lenders (by money invested in loans) and calculates that the estimated ROI at 1.518%. If you look at the page he uses, the 10th person is the worst lender of all… 15% worse than any of the other 25. If he had chosen the top 9 he would have had a 3.70% return. If he does the top 25 people the return jumps to 3.36%. If you take out the best and worst lender in that top 25, you have 3.94% return. (Note, I’m using a simple averge, not a weighted average because I’m Lazy). I’m not going to say that a 3.50% is great (I think you can do better at some banks), but it defintely beat my stock returns of late.
  • People’s Rate of Returns May Look Worse Than They Are – Here’s where the data gets even trickier. Prosper is always changing and adding new features. When I made most of my bad loans, I didn’t have their tool that says, “People who made this bid on a loan like this have an estimated return of -10%.” That’s powerful stuff. It changes your lending practices. Also, people may change their lending practices as they learn. I didn’t know that delinquencies were that important when I started. A few bad loans in the beginning can really torpedo your overall returns. However, those bad loans become less “impactful” (is that a word?) over time. If you look at the top 10 lenders mentioned before, they typically were early adopters and likely victim to these bad decisions.
  • What About Other Market Conditions? – People are likely going to pay off their mortgages before a peer-to-peer loan. After all, it’s their home! Yet we see that many people aren’t able to pay back their mortgages. It’s the worst it’s been in years. Perhaps judging Prosper’s performance now is like judging the stock market in 1929. If the economy gets back to normal, one could reasonably expect that fewer people would default on Prosper loans, right?
  • Lending Club is Performing Great For Me – I have 60 loans with Lending Club. Of those 60, 6 have been fully repaid, 53 are still current, and one is 16-30 days late. (The late one has already repaid 20% of the loan, so if I eat that one it’s not bad). My weighted average interest rate on these 60 loans is 9.21%. While this is not Prosper, the concept is the same. It’s great… I love it… I’m making a lot of money… ;-).

I stand by what I’ve said over a year ago… You have to treat Prosper loans like bonds – and that’s essentially what they are, right? I don’t know anyone who invests in a diversified bond fund and says, “It’s great… I love it… I’m making a lot of money…” Instead, you are going to say, “I’m more diversified than I was. I recognize that investing isn’t about making a lot of money quickly. I love that I didn’t lose 30-40% of my money in the stock market.”

Lending Club Update

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While I was asleep at the wheel on Friday, Lending Club came through with an update on their quiet period. When we last left them, I declared Lending Club is Dead. I admit that I was going for a sensational headline, but I still maintain that I wasn’t irrational. When a start-up company says that it is A) Unable to take new business, B) Unable to talk about why it can’t new business, and C) Unable to give a time-line for when business with resume, you have to wonder.

On Friday we learned that Lending Club Filed For SEC Registration. I didn’t see a hint of how long something typically waits to get through the SEC, so I’m going to be really conservative and go with a ballpark estimate of 14 years. (Again I’m being ridiculous, but with the last of information, that’s what I’m reduced to.)

I really like Lending Club – my loans are for the most part current. I say “for the most part” because I don’t want to jinx anything. It’s a little like how you don’t mention the no hitter when a pitcher hasn’t given up a hit for the first 7 innings. My portfolio at Lending Club is doing better than it was at Prosper. In fairness I took too much risk with Prosper, so by the time Lending Club came around, I was a good deal smarter about my loans.

Let’s hope that the SEC puts a rush on things to keep the industry moving. Without competition (Loanio, Loanio, come out wherever you are, the P2P lending space has been boring.

Lending Club is Dead

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[Update: It looks rumors of Lending Club’s death was premature. It was actually my best investment last year. You can sign up at Lending Club.]

lendingclubrip.jpgI, like many other Lending Club members, received a distressing e-mail a couple of days ago (Lending Club Reviewed). I waited until now to sort out how I feel about things. Here are the highlights that I found interesting:

Lending Club has started a process to register, with the appropriate securities authorities, promissory notes that may be offered and sold to lenders through our site in the future. Until we complete the registration process, we will not accept new lender registrations or allow new commitments from existing lenders… The borrowing side of our site will remain generally unaffected by this registration process; borrowers can continue to apply for loans and new loans posted after April 7, 2008, will be funded and held only by Lending Club… Until the registration process is completed, the company will undergo a quiet period and will not be able to respond to press and other inquiries about Lending Club or the registration process during that time.

In other words, they are shutting down the peer-lending service. They either are not willing to or unable to explain in more detail how long this may go for. The part about Lending Club fulfilling all borrow loans themselves is concerning. What happens if people don’t pay them back, will the company go out of business? Will they have to fill every borrower’s request that comes to their door? If not, how do they choose who to fund?

The biggest question is, “How long will everyone be in limbo?” Tech Crunch suggests that they might need to obtain a broker-dealer license from the SEC that would legitimize its operations. If this is the case, it might be quite a few months. You don’t just get a broker-dealer license from the Dollar Menu. There are regulations on top of regulations.

I am incredibly disappointed by this news. I ran a contest less than two weeks ago and gave away Lending Club memberships with $50 just for signing up. I will be pulling my money out as fast as possible. It makes no sense to leave it there since you can’t lend it and it earns no interest.

I have been worked for a number of start-up companies and they had one thing in common – they are extremely fragile. A high percentage of new companies fail. Often times they do everything right and the market conditions or something else just isn’t right. In this case it looks like Lending Club has the right market conditions, but something internally just isn’t right. I’ve talked to a few other Lending Club members – smart members who probably could have helped Lending Club avoid this problem in the first place – and they said they are gone and never coming back. They feel their trust has been violated. With each day that Lending Club can’t or doesn’t say anything to justify this inactivity, the more trust is lost. I might be blowing this out of proportion, but I’d rather err to the side of being conservative until I have reason to believe otherwise.

Note: I don’t believe this affects Prosper.com. The lenders do have promissory notes from the borrowers. Furthermore, Prosper has filed with the SEC for a loan resale marketplace, which tells me they are cooperating with the SEC’s requirements.