The online peer-to-peer (P2P) lending industry has become a viable alternative to standard banking over the past 10 to 15 years. As clients may ask about this, it's a good idea for CPAs to be at least conversant about the topic. P2P lending is an online platform that connects borrowers and lenders, thus bypassing traditional banks. P2P platforms don't lend money but rather serve as facilitators to the borrower and the lender.
With a click of the mouse, one can find loans online without going to a bank in person or waiting for approvals. Add in attractive interest rates, simplified applications, accelerated decisions, and an ever-more technologically savvy populace, and this new genre has become quite popular. My practitioner colleagues have noted that small businesses often use P2P platforms. That's not a problem as the accounting for debt is quite straightforward. The more interesting part of the equation falls on the investor side of this digital ledger. Yes, you can invest in loans.
The granddaddy of P2P platforms is Prosper.com, which launched in 2005 as the first P2P lender in the United States. Prosper.com boasts more than 850,000 members and says it has funded more than $13 billion in loans — for debt consolidation, home improvement, short-term bridge, auto, and small business. The loans range from a minimum of $2,000 to a maximum of $40,000, with terms of three or five years. Interest rates depend on a borrower's ability to repay and Prosper's estimate of risk. Prosper uses FICO scores along with its proprietary criteria, including debt‐to‐income ratio, stated income, bankruptcy history, credit bureau inquiries, and open trades reported on a prospective borrower's credit report.
Early last year, to learn more about P2P lending, I opened a Prosper.com account, linked my bank account, and transferred funds. Both traditional after-tax and IRA accounts are available. I then searched for individual notes in which to invest. The platform provides extensive search and filter capabilities and segregates loans into seven categories, ranging from AA (lower risk/lower return) to HR (higher risk/higher return), type of loan, term, etc.
Prosper sets a minimum investment of $25 per note but doesn't establish any ceilings beyond the $40,000 loan limit. Being a believer in diversification, I selected a basket of AA- and A-rated notes in the three-year and five-year categories. Technically, I was now the proud owner of $25 shares of several dozen loans. At the end of the next month, my statement showed that most of my borrowers made their monthly payments, one had paid off the loan entirely, and a few had missed their payments. Each payment was bifurcated into principal and interest, and my "available cash" was now enough to invest in another loan.
After a few months I decided to employ Prosper's "auto invest" feature. I selected my desired criteria and directed the platform to sweep available cash into loans matching those criteria. The process repeats each month. At year end I received a tax statement including capital gains details and Forms 1099-INT, Interest Income, and 1099-OID, Original Issue Discount. I eventually shut off the "auto invest" and am allowing cash to accumulate as the loans are paid off.
Summary: I opened this account as a learning experience and not as a serious investment opportunity. My investment was not material, and I consider whatever gains or losses I ultimately realize as "tuition to the school of life." It is imperative to remember that these types of investments carry risk — up to and including the loss of all principal.
Other platforms in this space include Upstart, Funding Circle, Circleback Lending, Peerform, Lending Club, and Bottomline Access.
Greg LaFollette, CPA/CITP, CGMA, is a strategic adviser with CPA.com, the commercial subsidiary of the American Institute of CPAs. To comment on this article or to suggest an idea for another article, contact Jeff Drew, a JofA senior editor, at Jeff.Drew@aicpa-cima.com.