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Peer-to-Peer Lending

24 August 2010 16 Comments

Guest post written by 20smoney reader, Brad

When looking at the balance sheet of a regional or community bank, you will find an unusually large portion of assets held in cash and short-term, liquid investments. Banks are awash with cash like never before. The appetite for lending among financial institutions has vanished over the last year and few loans are made that are not guaranteed by the Federal Government\U.S. Taxpayer through entities such as FHLMC, FNMA, GNMA, FHA and the SBA. Because of this government-mandated, taxpayer-funded guarantee, individuals are still able to get a first mortgage loan with relative ease, granted they have a 700+ credit score and enough liquidity for at least a 3%-5% down payment. That’s great for refinancing a home or purchasing a new one, but what if you need money to pay down credit cards, make a tuition payment or throw your daughter a fancy wedding? These loans are referred to as unsecured debt (not backed by collateral) and in the banking world they are becoming few and far between, regardless of your credit score. So where does one turn? Parents? Friends and Family? A new trend that has cropped up over the last couple years is peer-to-peer (P2P) lending. P2P lending is a transfer of funds between two parties or a group of individuals at a certain interest rate with an agreement of future repayment, without an official financial intermediary such as a bank. If you’ve ever lent $5.75 to a friend for lunch, and a few days later they gave back an even $6.00, you’re a P2P lender.

prosper

There are a number of peer lending internet sites that have popped up over the last few years: Prosper, the Lending Club and the Peer Lending Network, to name a few. What these peer lenders provide is a matching service between borrowers and investors with funds to lend. They offer borrowing rates much lower than other avenues and investment rates that are much higher than average market returns. These peer lending sites do the requisite background checks on potential borrowers (credit check, income verification, etc) and establish an interest rate for each individual based on their financial history and the amount they wish to borrow. This information is relayed to potential investors, who then may choose to lend the individual money based on the terms and rate of the proposed loan. Most I have seen are in the $7,000-$15,000 range, and each loan is funded by numerous investors (an individual may invest or “lend” as little as $50 per loan). These P2P sites facilitate the transaction, provide the legal documentation for the loan, and pass the payments from the borrower to the investor each month (after taking out a little slice for themselves). Additionally, should the borrower default on the loan, the company will attempt to collect on the debt and pass whatever funds they are able to recover along to the investors.

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Peer-to-peer lending can be great for borrowers and perilous for investors. Assuming you pass the vetting process and qualify for one of the lower rates, borrows are able to obtain funds in the 7.00% – 9.00% range. If the only other option of financing is with credit cards, P2P lending is much cheaper than plastic rates that can be as high as 20.00% to 25.00%. For an investor, default risk is your chief concern. Even if one diversifies their portfolio among a number of different loans, it only takes one or two defaulting to make your annual yield equivalent to 0.00% or below.

Full Disclosure: Lending Club Investor.

16 Comments »

  • Phil Harris said:

    This type of loan, P2P, has become so popular within the last few years because of the high interest rates charged by credit card companies as well as any loan process getting a bit harder to be approved for. Even such loans that were relatively easy to get, such as FHA loans, have upped their requirements. P2P is a great way for you to get 'quick cash' at a little bit of a rate. If you are interested in this you should looke around for these types of loans. They may be perfect for you in your needs are short term and relatively small loan.

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