By Matt Becker

A few weeks ago I gave some of my thoughts on the current enthusiasm around peer-to-peer lending. My main goal with that article was to warn people against getting caught up in the “can’t miss” attitude that often surrounds something new, particularly a new investment opportunity that’s delivered promising early returns. It’s not that peer-to-peer lending can’t be part of your investment portfolio, it’s that you shouldn’t expect it to be your golden ticket.

Since I wrote that article I’ve only seen more glowing reviews of peer-to-peer lending, again extolling the high short-term returns earned by the people singing its virtues. These reported returns have always seemed a little fishy to me, so I decided to dig a little deeper. Today, I want to share some of the results I found that the peer-to-peer lending marketers hope you never see.

The peer-to-peer lending returns they don’t want you to see

In my last article, I questioned whether there were publicly reported return results for peer-to-peer lending. It turns out there are, as one of the commenters pointed out. You can see them here, and they look pretty impressive, ranging mostly from 6-11% in the last few years.

But I found another site that lets you dig into those numbers a little deeper. The main purpose it seems is to let you experiment with different filters so you can design your own personal peer-to-peer investment plan based on past results. But I was interested in one specific question: what has the return been on loans that have completed?

Why was I interested in this specific question? Well, peer-to-peer lending is a young business. As a result, most of the loans they’ve given out have yet to run their full course. This opens them up to reporting much higher returns than you should really expect, as younger loans will have had less time to default. Realistically, how likely is it that someone will default on their loan just 6 months in? It’s much more likely that they will default after a couple of years. And given that all of the loans you give out will eventually have to end one way or the other, I thought that limiting the return numbers to only the loans that have actually completed might give us a more realistic idea of what to expect over the long-term.

So I used the filters to limit to all loans that either were fully paid, had defaulted or had been charged off. I used no other filters so that I could get as complete an understanding of these completed loans as possible. You can see the exact filter I ran by clicking here, but I’ve also included a screenshot of the results below:

When limited to completed loans only, every single loan grade except for the safest grade (the grade represents the loan risk, with a higher letter indicating less risk) has produced a negative return. The total return across all completed loans is -2.68% per year. That certainly paints a different picture than the 6-11% return seen previously.

**UPDATE**: One of my commenters, Peter Renton, pointed out a flaw with my research. He made the point that by including loans issued recently and limiting to only completed loans, I was skewing my results negatively because I was including recently issued loans that had defaulted but not recently issued loans that were still in good standing. Basically, my error is the same as what I have said that peer-to-peer lending sites are doing in skewing their results positively, just on the other end of the spectrum.

The solution to this issue is to limit my search to loans that were issued long enough ago to have had a chance to complete.The problem with this in regards to peer-to-peer lending specifically is that it leaves an incredibly narrow time frame to evaluate, and also doesn’t let you properly evaluate the performance of 5-year loans, as they don’t have enough history. It also doesn’t account for the massive influx in borrowers over the past year or so. The data in the new screenshot below only accounts for 5.6% of the total amount of money Lending Club has lent out over its history, most of which has been very recently. That leaves a lot of question marks as to where this thing is really going and only time will give us more answers.

Still, applying a fairer limit does paint a different picture, with more positive returns than I initially indicated here. I have included a new screenshot below that includes only completed 3-year loans issued between January of 2007 and August of 2010. I will let you draw your own conclusions. I am letting the rest of my post stand as is so that my original message is preserved.

**END UPDATE**

What do these numbers tell us?

First of all, I need to mention that just as with the positive returns people have experienced over the past couple of years, short-term results don’t prove anything. The poor returns earned over the past few years on completed loans cannot be used as definitive proof for what peer-to-peer lending will return going forward. It’s still in its infancy and we have much to learn.

With that said, it doesn’t bode incredibly well for the long-term prospects. After all, the loans you give out have to complete at some point. The negative success rate on such loans should give you strong pause about what will happen to your returns once you’ve spent a little bit more time with them. If peer-to-peer lending’s advocates presented these numbers instead of the return numbers that are heavily skewed towards newer loans, would people be as excited about this investment? I seriously doubt it.

Just to be absolutely clear on this topic, Lending Club itself has admitted that their reported returns are skewed in the positive direction. Allan Roth explains this in his excellent article summarizing his own experience with peer-to-peer lending. So you don’t even have to take my word for it. You can rely on the word of the very company who benefits the most from these inaccurately reported returns.

Conclusions

As with anything else, it’s important to take the time to do your own research before putting your money at risk. This is especially true when the thing you’re considering is being sold to you hard and even more true when the numbers presented seem a little too good to be true. I don’t honestly know the long-term prospects for peer-to-peer lending, but it will not be the magic bullet that gives you better returns for less risk. And a closer look at the numbers suggests that there may be some difficult times ahead for anyone who’s committed a significant amount of money to it.