Need a Loan? Ask a Stranger: The Power of Peer-to-Peer Lending

Peer to peer lending
Peer to peer lending

Interest rates are at their lowest levels since 1971, but even people with excellent credit scores are finding it hard to obtain loans from banks more comfortable with lending to companies than to individuals. For a homeowner with an underwater mortgage, or a repentant over-spender struggling with a high APR, refinancing for lower interest can make a difference over the long term. But with banks still cautious, many people are looking elsewhere to make ends meet.

And for some of them, the solution is to get personal.

The concept of peer-to-peer lending is not new. Websites like Kiva.org have been around for years as a means of helping small-business owners in the Third World get the cash they need to create or expand their businesses. But the Great Recession and its aftermath have brought with them a new need, new clients, and several companies to fill the void left by traditional banks and lending institutions.

With peer-to-peer lending, the people determining your fate aren't sitting behind grand mahogany desks in the big bank downtown – they could be your neighbors, your friends, or complete strangers, sitting behind computers down the block or around the world.

Fringe Finance Goes Mainstream

When Fortune 500 ranked the peer-to-peer lending company Prosper as one of the top 500 companies of 2009, the niche industry was deemed an innovation in lending. However, amid SEC inquiries, the industry itself seemed to be on rocky ground. Still, Prosper and its chief competitor, Lending Club, (both located in San Francisco) have continued to grow and thrive. Prosper has seen year-over-year growth of 367%. Lending Club boasts 19 consecutive quarters of positive returns, and was recently named to Forbes' list of America's Most Promising Companies.

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While the national average rate that borrowers pay is 11.41%, peer-to-peer lending offers rates starting in the mid-6% range, with 6.74% for Lending Club and 6.59% for Prosper.

These companies are positioning themselves not just as a boon to borrowers, but as a winning choice for investors, whose small bundles of cash might otherwise be earning 1% or less in certificates of deposit or savings accounts. In peer-to-peer lending, the average return is 10.6%. To date, Prosper has handled more than $350 million in loans; Lending Club, $680 million.

How It Works

The process for obtaining a peer-to-peer loan is not unlike the process for obtaining a traditional one, although there's far less paperwork. Aspiring borrowers create a free account on the company's website and fill out a loan application that includes a credit check, requested loan amount, and the reason for the loan. Potential investors build an online portfolio, browse requests, and determine which requests to fund, and in what amounts.

The years since the financial collapse have brought changes to the dominant role of the big banking system, and with them, the rise of creative and alternative ways to pay down debt, plan for the future, and customize short-term, low-interest loans to meet immediate needs. Should the peer-to-peer lending trend continue to grow, short-term loans could be merely the start of a full-fledged peer-to-peer banking system, with a variety of investment and savings products.

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Should the niche market continue to grow and become a threat to traditional banks, which are already struggling with an environment different from that of even five years ago, this little fringe business might become the money-lending industry to beat.

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Molly McCluskey does not hold positions in any peer-to-peer or other lending institutions. Follow her finance and travel tweets on Twitter at @MollyEMcCluskey.