July 10, 2007, 1:32 am

More on Social Lending

by: The Financial Blogger    Category: Social Lending
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First, a quick note to mention that my article about Realtors in on the 108th Carnival of Personal Finance hosted by Broke-A$$ Student.  I am getting in the habit of participating in this great carnival. Definitely a good way to get in contact with other bloggers!

After the interview I had with David Andreatta from the Globe and Mail and Canadian Capitalist’s post on social lending, I thought I would go a little bit further in my thoughts. Why social lending appears appealing to me as most people think it is almost evil and doesn’t make sense whatsoever. I can appreciate their concerns as lending money to individual can be hard game as all players are not necessarily playing fair. There are golden banking rules to respect in order to be successful. Reading about how banks look at you on this blog can be very useful to change your thinking toward lending mentality.

Why would I bother lending to individuals when I can get 4% on a saving bank account with no risk?

This reasoning is not bad at first. In fact, why bother investing money anywhere when you are 100% sure to get 4% in your pocket right? Most people that will tell they aim 15% return in their portfolio might have started investing two years ago. Or even worst, they might have never reached their goal once and still pretend. On a borrower’s perception, lending money on a social lending website is being done thinking they can earn 10% on their investment. Therefore, the spread before taxes is now 6%. According to Prosper’s rate chart, only AA credit will be able to borrow at less than 10%. Therefore, I think the potential return is there.

Why lend money when I can invest in mutual funds giving me the same expected return?

Although I am not a big fan of diversification within the same financial product, I think that diversifying ways of making money can be very smart. When you lend to individuals, your return will not be correlated too much to the stock markets. Therefore, you create another asset that is independent from your investment. Rental properties incur the same kind of risk than social lending except that it requires much bigger investment. Nonetheless, both assets require that you trust individuals capacity of repayment. The major difference is that your rental property will increase in value; however, you are tied up with a mortgage that can get you in big trouble if you can’t make the payment. I think that your portfolio should be spread among different type of investment products such as mutual funds, rental properties and social lending.

What is the tax implication of social lending income?

This is definitely one of the bad points of social lending. Income earned thought loans are interest by nature. Therefore, the income is added to your taxable revenue and is subject to your marginal tax rate. For most of us, it means that 40% of what you earn will not get in your pockets but in the government’s pocket. Unless there is some taxation rule that I ignore, I don’t think there is any escape to this. Unfortunately, the borrowers can not pay you the Canadian way.

From what I know (as I was not given the chance to try any system yet), social lending can be another great tool to create assets and to produce income over time. As it is the case with regular investments, your performance will be determined by your involvement (effort and time) toward your credit portfolio.

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Comments

Hi Mike,

Do you know what are some of the licensing and regulation both provincial and federal that these social lenders in Canada:razz: must apply for and whether these regulation are different in US and Canada.

Thanks much.

by: The Financial Blogger | July 26th, 2007 (6:48 am)

Hi Darius,

Unfortunately, I know little about the law structure behind social lending. You would have to refer to a law firm I guess or the Government.

Cheers,
FB.