Lending Club vs Prosper
Peer to Peer Lending

Peer-to-Peer Lending: Borrowing in the Digital World

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In today’s low interest rate, tight-credit environment, both borrowers and investors are facing a true paradox. For borrowers, those in need of financing to fund a business, or consolidate debt, or pay off medical bills, credit is still tight for all but the most creditworthy.

For investors, interest rates available on fixed savings vehicles or bonds are at their historic lows offering very little in investment returns. But a new, burgeoning business phenomenon seems to be providing the relief that both need during these difficult economic times.

Peer-to-peer lending (P2P), also referred to as social lending, has become a billion dollar bank-less loan industry that is giving investors and borrowers a much needed alternative to address their most financial concerns.

The concept sprang from the emergence of web technology, social networking, crowd-sourcing and an overall dissatisfaction on the part of consumers to work with greedy intermediaries who do little more than increase the price of just about everything.

In its simplest format, P2P matches private borrowers with private lenders using a collaboration platform similar to social networking sites such as Facebook. Borrowers post their needs, and lenders can choose from among borrower profiles and invest their funds in a loan pool designated for that borrower.

Peer-to-Peer Borrowing has Credit Restrictions

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Make no mistake; P2P lending is not an alternative lending source for people with poor credit. In order to attract the legion of private lenders, or investors.

P2P lenders are interested in loaning money, but they want “good investments,” which means it will only accept loan request from creditworthy individuals with scores in the mid to high 600s and low 700s.

The accepted requests are then categorized by type of loan and the risk profile of the borrower. More than 60% of P2P loan requests are from people who want to use the proceeds to consolidate debt.

Should You Use Peer to Peer Lending?

Focusing for the moment on debt consolidation, which is the most oft stated purpose of loan requests, does P2P lending provide the best alternative? The simple math would say “yes” if you can reduce your interest rate costs from a smothering credit card rate of 19 to 28% down to 13%, which is the average interest rate on P2P loans.

P2P interest rates are determined by the lending pool based on the profile and credit standing of the borrower, so rates can be as low as 7 or 8 percent and as high as 15 or 16 percent.  Plus, converting your credit card debt into installment debt can automatically increase your credit score.

Peer to Peer Positives

• Lending amounts from $1000 to $25,000
• Interest rates are low for unsecured loans
• Fixed loan rate
• Loan terms are for three to five years
• There are no prepayment penalties
• Reported to credit bureaus as an installment loan
• Low loan fees
• No intermediary – funds originate from the Web community

Peer to Peer Negatives

• Accepts “prime” borrowers only – 650 or better credit score
• Must make public (in the lender community) your personal bio and loan purpose

For prime borrowers who have been turned down for personal or business loans for reasons other than their risk profile, P2P lending could be the best alternative for obtaining unsecured financing. P2P loans are gaining wider acceptance in the legal community for use in documenting “family loans” so that lending between family members can be formally structured. For small business owners, it may be the only source in a tight-lending environment.

Among the top social lending sites are Lending Club and Prosper.

Peer to Peer Lending for Investors

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For investors, the current sluggish economy translates into low yields on debt investments including fixed yield instruments like CDs as well as yields on safe bonds like U.S. Treasuries or high quality corporate bonds.

Retirees who rely on fixed income investments struggle the most, as current yields are not keeping pace with the accelerating rate of inflation.

So, when an investment alternative that can generate higher yields with a moderate level of risk comes around, investors will take note, as they have with peer-to-peer lending (P2P).

P2P, popularly referred to as social lending, is rapidly becoming a portfolio addition for investors who have grown tired of the low yields with conventional investments. Peer-to-peer lending has emerged as a preferred source of loans for many individuals and businesses still facing difficulties in obtaining conventional financing from the banking industry.

In addition to the availability of financing at lower rates, many borrowers are attracted to P2P simply because it is the “anti-bank.” The concept was born out of the convergence of Web 2.0 technology, social networking and the preference for community collaboration in solving local problems.

P2P lending companies, such as Lending Club, Marketplace and Prosper simply use these technologies to bring together a community of borrowers and lenders whose financial interests can benefit one another. Borrowers need financing at reasonable rates, and the lenders are actually investors seeking higher yields.  It’s a rare win-win situation.

The success of P2P lending is predicated on the quality of the investment offering, so the clubs or sites must be very selective in the loan requests they allow to be posted. So, they tend to only approve requests made by “prime” borrowers, those with credit scores of 650 or above and good overall risk profiles. As a result, they decline nearly 90% of the loan requests. This is the only way they can promote to investors a stable income with only a moderate risk exposure. 

Investors can “loan” as little as $25 to any borrower they choose. They can spread larger amounts around to dozens or hundreds of borrowers. Many P2P investors enjoy the aspect of helping certain types of borrowers, so they can target their lending to those whose profiles more closely align with their “philanthropic” desires. 

The loans or “notes” are offered to investors by a prospectus which details the loan request, risk profile, and the background of the borrower.  The interest rate, or yield, of each note is established individually based on the risk profile and the loan term. Notes offered through borrowers with very good credit might yield 7 to 9% while notes offered through less creditworthy borrowers could yield as much as 15%.

Should You Invest with Peer to Peer Lending?

P2P investing is not without its risks since there is always the possibility of borrower defaults. Business start-ups are especially prone to failure. Still, the fledgling P2P industry is growing rapidly and its legitimacy and viability has strengthened as the amount of issued loans continues to skyrocket, and it has come under the watchful eye of the SEC.  If you’re investor who understands the benefits of creating a balanced and diversified portfolio, adding a P2P investment can be an effective way to boost your yield.

Peer to Peer Lending Investing Positives

As reported by Javelin Research investors have earned an average net annualized return of 9% since 2007.

• Loan quality is enforced through strict selection criteria
• You can diversify your loan portfolio among hundreds of borrowers thereby reducing your risk exposure
• You can review the background and risk profile of each borrower
• Yields generated from large, diversified loan portfolios are relatively stable
• It’s easy to invest and easy to reinvest your interest and principal payments each month.
• There is a secondary market for selling your notes
• You can earn a good return while doing good for other people
• Account fees are reasonable so they don’t eat into your returns

Peer to Peer Lending Investing Negatives

• Borrower default risk