The cost of higher education is ridiculous. Each year schools raise the costs of going to school while simultaneously giving away less and less money in the form of tuition aid. Consequently, most students have to rely on government loans to pay for the cost of going to school. But it has gotten to the point to where even that is not enough.

What is a student to do?

Option 1: Bum mom and dad for money. If your parents are well off, this is a viable option. Unfortunately, most Baby Boomers don’t have enough for their own retirement, let alone to help their children through school. So many students might come up empty handed on this one.

The other drawback of asking your parents for money is by accepting it, a student also accepts their parents right to meddle in their life. It’s like how the federal and state governments work. The federal government tells states “Sure! We’ll give you money, but you have to do what we say.” Parents will exercise this same power on you if you take their money. If you want to remain sovereign, don’t take money from them.

Option 2: A private loan from a bank. If a student wants to avoid their parents meddling in their lives, their best option is to get a loan from a bank. A bank doesn’t care if you stay out on weeknights or that you play video games too much. They just care that you pay them back on time.

The problem with getting a loan from most banks require a co-signer to take out a loan. For some students this may be difficult to acquire. Their first option is their parents. But I’ve met plenty of students whose parents for some reason or another didn’t have enough assets to feel comfortable co-signing on a loan. There’s a classmate of mine in law school who has this exact predicament. He needed some extra money, but his parents couldn’t co-sign on a loan. They were just hit with some heavy medical expenses and were looking to file for bankruptcy. This poor guy needed the money or he was getting kicked out of law school.

Additionally, if your parents co-sign, you give them permission to meddle and we don’t want meddling.

Option 3: P2P Lending. Most Peer-to-peer lending sites, like Prosper, can be a student’s best friend. Unlike Option 1, Prosper lenders won’t meddle in a student’s life. If you pay them back, they’re happy. Unlike Option 2, Prosper doesn’t require a co-signer. This can be helpful for students who can’t get a co-signer. It also keeps busybody parents out of your life.

While I don’t suggest peer-to-peer to fund your entire education (you can’t get the delayed payments like traditional student loans), peer-to-peer loans are perfect for students to pay for books or other unexpected costs during school.

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Brett McKay is the author of The Frugal Law Student, a personal finance from the view point of a law student. The Frugal Law Student was recently named the best law student blog by the ABA Journal. When he’s not blogging or studying law, Brett enjoys sipping yerba mate while playing Wii Sports.

For a very long time, I believed money management was a simple matter of knowing math. I thought that the reason why people had trouble saving money was that they didn’t understand a few basic personal finance concepts. I figured, if everyone knew how compound interest worked, they would surely invest money today in order to have twice as much in 7 years.

I still believe that math plays a predominant role in personal finance. However, I’m starting to think more about psychological factors. I noticed that people in debt may be compulsive shoppers. Some people bought comic books and have decided to sell them (see personal goal #8). For others, Magic Cards are the thing. If you find yourself in debt and spending money you don’t have on these hobbies, it may be time to look for a new hobby. I decided to take up writing, which actually makes money. My wife prefers hiking, a very frugal hobby which helps her health.

Some have marveled at how the writers above have made such progress on their debts. Obviously they educated themselves about personal finance and took a series of logical steps to turn their finances around. I would go a step further and suggest that their focus helps them psychologically. Perhaps Ben from Money Smart Life said it best:

When I’m focused on working hard to increase my salary, saving more money, and getting a better investment return I tend to spend less money. I’ve had to work hard to build our net worth, the last I want to do is turn around and spend it away. On the other hand, if I’m not thinking about how many hours I had to work to earn money or what our portfolio returns are, I’m more likely to spend a little more money.

I have seen this in my own personal finances since I started writing about money. Perhaps the key to making the most your money is to do something that keeps your mind focused on the goal rather than some mathematical equation as I originally believed.

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Lazy Man has been a lender at Prosper since February 2006. His lending has been written up in the Globe and Mail, Canada’s largest national newspaper. He is the author of the personal finance blog, Lazy Man and Money. He enjoys watching Boston sports while sipping diet cola.

Way back when, I thought we were doing well financially. We were making money and we were able to pay all of our bills. Every few weeks I would sit down and cut some checks for the amount showing as due.

I didn’t think much of it at the time, but I always paid the minimum amount due showing on my credit card bill. Why do I need to send more? Just cut a check for the amount that they want and it’s all good.

I was wrong… very wrong.

Now that I’ve learned a few things about our finances, I see the error of my ways and I am going to show you what I learned (thanks to a handy calculator at Bankrate.com). Take for example the graph below:

Let’s say you have $5,000 balance on your credit card and you do not use it anymore. You decide to only pay the minimum amount due on your bill in order to pay it off. In this example, the minimum payment is 2.5% of the amount owed. Each time you pay the minimum payment, your balance would go down a little bit and so would your next minimum payment. It would take you over 20 years to pay off your card using this method.

On the other hand, let’s say that you decide to take that first minimum payment (which is $125 in this example) and set that as the amount you are going to pay to your credit card every month. You are used to the payment, so why not just keep paying that amount?

It’s a pretty good idea because your debt will be paid off in less than 5 years by doing it this way.

Pretty amazing, isn’t it? It makes me feel a little silly to admit that I used to only pay the minimum payment all the time (and we were also still charging on our cards, but that’s a different story!).

That’s not all, though. Just look at the money you can save by paying more than the minimum:

You can save over $2,700 in finance charges by paying $125 a month versus just the minimum payment! I can think of a gazillion better uses for $2,700 than giving it away to my credit card company. What about you?
It’s easy to get in the minimum payment trap. I was there and back then I didn’t think twice about only paying what our credit cards said we had to pay. But when you run the numbers, paying a fixed amount a month can make a huge difference.

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Tricia is the blogger behind Blogging Away Debt. In her blog, she documents her family’s journey to pay off over $37,000 in credit card debt. Part of her debt reduction plan included a loan from Prosper.com. It originated in June of 2006 and was paid in full in October of 2007.

When looking to invest or generate income with peer-to-peer lending, it is important to consider what your goals are and what part this money plays in your overall financial situation. Understanding what you have in mind for this money can help you then determine how much money you should have in the peer-to-peer marketplace.

Prosper Lending as an Asset Class

In order to fully understand the role that this type of money plays, you first have to understand how it works as an asset class. The most common types of assets are:

• Stocks
• Bonds
• Cash
• Real Estate

Sure, there are other derivatives of asset types, but these are the four most common types of assets that make up a typical person’s portfolio. So, where does peer-to-peer lending fit in?

When you lend money to someone on Prosper, it is essentially the same as buying a bond. A bond is defined as: “A certificate of ownership of a specified portion of a debt due to be paid by a government, individual, or corporation to an individual holder, usually bearing a fixed rate of interest.”

For example, when you buy a U.S. Savings Bond, you are lending money to the government, and in return they agree to repay you over a specified amount of time plus a specific amount of interest. The same transaction happens in peer-to-peer lending-only the agreement is between two individuals.

Comparing Prosper Loans and Bond Risk

All bonds are not created equal, and depending on the issuer, a bond may carry more or less risk than another bond. Take government bonds for example. These are considered the safest of all bonds because repayment is backed by the full faith and credit of the government. This security comes at a price-lower interest rates.

Then consider corporate bonds. These are companies seeking loans from investors. Since the repayment generally isn’t guaranteed, they typically command a higher interest rate to attract lenders. Very large and stable corporations will typically have lower interest rates, whereas very small or financially insecure companies may offer very high interest rates because the possibility of defaulting on the bond is much higher.

Prosper loans are no different. The higher the risk of default, typically the higher the interest rate you can receive. If you are interested in funding a Prosper loan to someone with a poor credit rating, relatively high debt-to-income ratio and a 21% interest rate, you have to realize that this is no different than buying a bond from a small start-up internet company that has a chance of failing. With the higher rate comes added risk.

Where This Fits Into Your Portfolio

Now that we’ve determined that peer-to-peer loans are nothing more than personal bonds, where do they fit into your portfolio? To answer that, it comes down to what your goal for this money is. Do you want to generate regular income that you can use today? Do you want to simply generate income so that you can place the money into more Prosper loans? Or is this all part of the bigger picture where you’re looking to simply accumulate more money for long-term goals such as retirement?

Short-Term Goals

For short-term income you can focus more on diversifying across different Prosper loans and cash you may have elsewhere compared to how it fits within your overall portfolio. Short-term goals can put this money at risk, but you are doing so knowing that it is money you can afford to possibly lose or earn less since it isn’t being used to fund something like retirement.

Here you want to focus developing a good mix of loans and cash that produces the highest reward with least amount of risk. As far as how much money you should be putting into this practice, you really just want to make sure that you are comfortable with the amount of funds you have committed and that tying this money up isn’t sacrificing your other long-term goal funding.

Long-Term Goals

When P2P lending with a long-term focus, things are a little bit different. Since this money makes up part of your portfolio that shares a similar goal, you want to make sure they work together and you keep your risk/reward balance in-check.

You may have heard about typical asset allocations before that are based on age and risk-tolerance-90/10 mix of stocks and bonds, 70/30, 30/70, and so on. Conventional wisdom suggests that the younger you are, the more aggressive you can be with stocks because you have more time to recover from losses and see higher long-term average returns. As you age and approach retirement, you generally move to a more conservative approach that protects principal since you likely are or will be living off of that money.

Comparing Prosper loans to bonds is only a start, because you first need to know what type of bonds you’re dealing with. Remember, most of the asset allocation models consider the bond portion as a very conservative bond position that consists of primarily government bonds for guaranteed principal. When lending money on Prosper, you aren’t getting a guarantee that the government will pay you back, so these loans are much more like corporate bonds where there is a varying degree of risk.

That being said, does this mean if you consider yourself someone who should be in a 90% stock and 10% bond portfolio that you should allocate 10% of your assets to Prosper? Not exactly. Remember, in a typical asset allocation strategy, the bond holdings are used to safeguard your stock declines with protection of principal and interest payments. Thinking about corporate bonds and Prosper loans is closer to comparing them to stocks in this regard.

So, if you have a $100,000 long-term portfolio that is appropriately invested in 75% stocks and 25% bonds, what would be reasonable as a peer-to-peer lending allocation? If you’re seeking low-quality loans and trying to obtain the highest interest rates, your peer-to-peer lending holdings should be treated more like stock. This means that of your $75,000 in stocks, you should either sell some of the stock position to put in Prosper, or if adding new money, treat it as purchasing new stock and adjust your bond holdings appropriately.

If you are being much more conservative with your Prosper lending and seeking only the highest grade loans, you have a bit more flexibility. While even the highest rated borrowers aren’t guaranteed to repay the loan, the likelihood is much higher. For the most part, you can probably be fairly comfortable in considering this money as part of the bond portion of your portfolio.

Final Thoughts

Ultimately, your financial portfolio is more of an art than science. There are no rules that are set in stone, and it is up to you to determine how much risk you’re willing to take. Lending money on Prosper is a great way to add diversification to your portfolio, but you do need to understand how this money fits into your financial picture. Different goals will determine how much money you should allocate towards peer-to-peer lending and the amount of risk you should take.

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Jeremy is the author of the personal finance blog Generation X Finance, which aims to help a unique generation achieve financial independence. Jeremy also writes for the Financial Planning topic over at About.com. He currently works as a retirement plan specialist with a focus on employer-sponsored plans.

If you want to be wealthy, what’s the first step? Is it saving for an emergency fund, learning how to invest or embracing the frugal lifestyle? No - the first step is planning.

Many financial problems are caused by a lack of planning, and the reason why many people can’t bring wealth into their lives is a lack of planning, too. Someone who launches into investing without a plan may be excited at first by the idea of buying dividend producing stocks. After that idea loses its sparkle, that person might read a bit more and discover index funds. Future stops and starts continue to wreck any hope of getting ahead.

Knowing all your options is the most important part of planning. Before you start out building wealth, you need to come up with a plan (preferably written) for a number of areas:

• Am I prepared to eliminate debt from my life? How will I do it?
• Do I have adequate protection in place for myself and my family - wills, insurance, taxes and
  emergency funds?
• Do I have an investment strategy? Am I going to invest in the market, in real estate or in other
  alternative investments? What are my options?
• Is my current lifestyle reasonable, or can I save money without compromising my happiness?
• Does my work complement my goals or hold me back?

And most importantly:

• Why do I want to be wealthy? To give back? To have financial freedom? To support my business?

Often when people are young they don’t feel the need for planning. If you are young enough to feel that you have time to recover from your mistakes, you may think planning is a waste of time compared to “doing.” Yet at the same time making mistakes due to a lack of planning can come back to haunt you for years: failing to plan to manage your finances, your career or even your health or personal life can have long-lasting effects.

If there is any area of your financial life where you feel that things aren’t going well, take a step back and consider whether you have a plan. I recently started to wonder whether my investment strategy was well-thought out. I’ve been an investor in the stock market since high school, but I have never looked into or even seriously considered other avenues as they became available - real estate or alternative investments like Prosper or buying into businesses. Now that I’m interested in these areas, I am creating a plan; not because I’m tentative or have doubts about my ability to succeed, but because I know that with a plan I will succeed.

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Steve S. is the author of Brip Blap, a blog about personal finance, health, career management, productivity and self-improvement. He lives and works as a contract governance and audit consultant in the New York City area, and has lived in Germany and Russia. He is an active lender at Prosper.