This is not your father’s bank loan. In fact, it’s not his blue-chip bank stock either.
Peer-to-peer lending is a unique vehicle that offers options for both borrowers and investors. People in need of a quick cash infusion can obtain a loan of thousands of dollars, provided they meet credit requirements, while on the other side of the ledger, investors looking to diversify their portfolio can put up money to fund one or more loans.
But you can’t find peer-to-peer lending at any bank, credit union or any bricks-and-mortar establishment. It’s all done online.
Here’s how they work: If somebody needs money to fund some home improvements, they can visit the websites of firms such as Lending Club or Prosper, fill out an application and, if they cut the credit muster, have the money deposited in their account in a matter of days.
But it’s not cheap. Depending on the size and term of the loan and the customer’s risk profile, interest rates can range from as low as six per cent all the way up to 35 per cent.
These same companies are also on the lookout for investors wanting a piece of the lending action. For as little as $25, an investor can fund part of a customer’s loan. If they’re particularly flush they can provide the entire loan themselves.
But these facilitators of peer-to-peer lending don’t provide loans to just anybody. Mitchel Harad, San Francisco-based Lending Club’s vice-president of marketing, says its unsecured loans of up to $35,000 are geared towards people with “good to excellent” credit only.
What the recipients do with the money is up to them, of course, but 70 per cent of Lending Club’s customers use the proceeds to pay off their credit cards and other high-interest debt.
Merely checking the company’s website to compare interest rates won’t affect a potential customer’s credit score, he says. If they qualify, Lending Club will present them with a pre-approved loan offer.
“There’s no collateral. You don’t need to put up a car, house or microwave,” he says.
Unlike a traditional bank loan, however, dozens or even hundreds of investors could opt to invest in them. The majority of people lending put up $25, $50 or $100 per loan. The interest and payments go to each investor on a pro-rata basis over the term of the loan – either 36 or 60 months – while Lending Club takes a one per cent servicing fee.
The “consumer credit asset class” is certainly growing. Within a few years, it has become a billion-dollar industry. Lending Club, in fact, recently surpassed the $1-billion mark in loans after $82 million in loan originations in October. Prosper, meanwhile, is sitting at about $425 million after $15 million in loan originations in the same month.
Robert Warren, a business professor at the University of North Dakota, says peer-to-peer lending is one of the emerging forms of alternative financing for people who either can’t use traditional sources or aren’t interested in them.
“The reason the (interest) rates are so high is that most of the users don't qualify for traditional sources because of their risk profile – it could be they lack enough equity or the risk is too great,” he says.
Brad Lensing, chief marketing officer with San Francisco-based Prosper Marketplace, believes two things are driving the sector’s growth.
“On the borrowing side, we provide an additional option outside of banks for folks to consider getting their finances in order. One the lending side, it’s about providing access to our lenders to an asset class in the personal loan category which historically they haven’t had access to,” he says.
The average loan at Prosper is approximately $8,500 and it has returned about 10 per cent to its investors since starting up in 2006. It also has a loan default rate of about eight per cent.
And just like a traditional investment portfolio, the company recommends investors put your money in a number of loans to diversify their exposure.