Sometimes it seems that the more dire your need for a loan, the more likely you are to be ignored by the banks. While there has reportedly been a loosening in the credit market, the reality for many people feels quite different. It's not surprising then, that peer-to-peer lending is increasingly catching on with borrowers, as well as with small investors looking to make a profit by providing the loans.

Peer-to-peer lending, or social lending, refers to financial transactions that occur directly between individuals without the involvement of a traditional financial institution. And it's not some passing fad. The Lending Club recently announced it had passed $200 million in total loan originations. Not bad for a business that opened its doors in 2007. And it's just one of many sites such as Kiva.org, Zopa.com, GreenNote.com, and Prosper.com. (DailyFinance writer Alex Salkever reported last month about his experiences as a Prosper.com lender.)

"It Was a Lifesaver"

"I'm not sure what we would have done if we hadn't found Lending Club," says Jenn Waters, who along with her then-fiancée, got a loan of $25,000 in less than two weeks this past summer. "We aren't lazy people that can't pay our bills. We just fell on hard times and had some bad luck, such that we couldn't get a handle on our debt. Plus we had our wedding to pay for in August," says Waters.

The couple tried to get a bank loan, but they had no equity in their condo, so they were forced to look for other options. When Lending Tree pointed them to the Lending Club, they had never heard of peer-to-peer lending. "We did a lot of research before we committed to trying it and spoke to company representatives on multiple occasions. We wanted to know who were dealing with," she adds.

The Waterses will pay off their loan in three years, and the money wasn't cheap: Their loan has a 13% interest rate and monthly payments of $843. However, Jenn Waters says, "It was a lifesaver. Our goal was to be in a much better position a year later, and we are definitely working toward getting there."

Bidding to Borrow, Bidding to Lend


Thanks to the Great Recession, many more Americans have found themselves having to borrow money just to cover the necessities. According to a MetLife (MET) study of the America dream, from 2009 to early 2010, nearly half of Americans said they had given money to a family member so they could pay their bills, and more than a third have had a family member give them money. But family isn't always an option when finances get tight.

Think of P2P lending sort of like a financial version of Amazon (AMZN) or eBay (EBAY), where borrowers and lenders can post their offerings, and each tries to get the best deal they can find, explains Carrie Coghill, director of consumer education for FreeScore.com. "This platform allows borrowers and lenders to choose their own terms and interest rates so that the exchange can work for varying financial needs and wants," she says.

And not all of the loans are between complete strangers. Peer-to-peer lending sites can be used to set up structured loan programs between friends and family members as well.

"If you're really strapped for cash and you might not be able to get a loan through a bank because of a spotty credit history, you may have a better chance of getting one through a lending site, though it will cost more in terms of interest," says Coghill. "If you desperately need money for an emergency, this may be a reasonable option," she adds. "If you have various credit cards that are charging higher interest rates than a P2P loan, you may want to pay off your credit cards and start paying the lower interest."

Chris Larsen, CEO of Prosper.com, rattles off the advantages for borrowers, "Low rates, fixed rated, no hidden fees, a quick and simple process."

Higher Risks, Higher Profits

There are also incentives for the lenders. Investors can earn on average nearly 10% in annualized returns on P2P loans -- higher than CDs or some stocks, says Coghill. P2P companies typically charge a 1% service fee that's subtracted from the interest gained on the loan.

Investor Curtis Arnold has averaged 11% to 13% returns on his P2P loans. "I like being the bank. I'm not a big fan of banks, and this is a way to cut them out of the picture," says the founder of CardRatings.com, which educates people about credit cards. Arnold is also co-author, with Beverly Blair Herzog, of Person-to-Person Lending.

He has loaned thousands of dollars over the last few years, online and offline. While one $40,000 loan was delinquent by four or five months and the terms had to be modified to lower the borrower's payments, his experiences as a lender have mostly been positive. "This is very cool -- a win-win when done right," says Arnold.
Greg Collett, a financial markets lawyer, has lent money over the last few years to about 350 people online via Prosper.com and LendingClub.com. He says his net annualized returns are around 14% and his loans are typically $80 each. Often, individual lenders will finance only a fraction of a requested loan, spreading the risk from a given borrower among multiple investors.

"I've been careful not to invest too much while I learned how the system works and what doesn't work," Collett says. For example, in his experience, people who are trying to pay off high-interest credit cards are more likely to pay you back than those who are taking on more debt for things like an addition on their house, starting a business or going to school," he says. And for some borrowers, the experience can be less than rosy.

Great as P2P has been for Collett, he offers these words of wisdom to potential investors. "Some of the information provided on borrowers is more reliable than other information. For instance, credit scores and whether a borrower has been delinquent are harder facts than a borrower's occupation and income because they can be easier to fudge," he says.

Secondly, there is interest rate risk. If you make a 60 month loan at 12% and rates skyrocket to 15% two years down the road, you can lose big. His recommendation: "Mitigate the risk by making a 36-month loan instead."

Hidden Risks of P2P Lending


A couple of other risks don't get much publicity, Collett notes. "You're taking credit risk on sites like Prosper and Lending Club. Lenders are actually getting a note from either Lending Club or Prosper that represents a promise by those companies to pay the lender if the borrower pays them. So if either site goes bankrupt, then that would be a problem."

Also, you're relying on the sites to accurately gather information on borrowers: credit scores, creditworthiness, debt loads, etc. And you'll be counting on them to either pursue any loans that go into default or to sell them off to a collection agency. He says he's known of instances when loans have gone into default and little effort was made to get the lender any money back.

As with investing generally, diversify and spread your risks. "Instead of $10,000 for one loan, make small investments so your money is in many buckets," advises Arnold.

Tips for Borrowers


Those seeking loans would do well, too, not to go blindly into the process. Understand what your credit score is prior to posting your request. You will be "graded" on your ability to repay the loan, says Denise Beeson, who teaches small business management classes at Santa Rosa Junior College in California.

• Provide a Good Reason for Why You're Borrowing. "It is very important that you be clear to the reader what you will use the funds for. Vague or poorly worded applications are sorted out quickly," she adds.

• Get Real.
"You've probably been refused by traditional lenders, now you're taking a high-interest loan. You probably can't afford it," says Coghill. Rates can range from 8% to 21%, depending on credit scores. There can also be large late payment fees. They can be 30% of a member loan if a borrower's payment is 60 to 90 days past due.

• Don't Assume Anything.
"Lenders on P2P sites are just as capable of hiding terms in the fine print as banks and credit unions," says Coghill.

The peer-to-peer lending genie is out of the bottle, and it's likely only to grow. In fact, "P2P lending is projected to soar to $5 billion in outstanding loans by 2013," says Timothy Burke, CEO of National Family Mortgage, an online resource for families structuring and managing real estate loans with their loved ones. Adds Prosper.com's Larsen: "We're seeing more large investors joining the platform and adding P2P to their portfolios and we see that continuing."

Folks like small-businessman Chris Dagger hope so. The CEO of Custom Confections of Warren, Mass., has used P2P to finance his the expansion of his business. "We have a small three-year loan through Lending Club that allowed us, in just over a year, to grow to three locations," he says. "When it comes to raising finances, I wouldn't do anything but peer-to-peer. The bank is the last place I'd go. I'll happily tell American Express (AXP) what to do with their Platinum Card."

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Dgtl CntaX

I just wrote a post about my experience with LendingClub and p2p lending. This is a great opportunity for both lenders and borrowers; I'm glad to see this taking off. Check out my post here: http://lucracy.com/2011/01/the-rise-of-p2p-lending/

February 15 2011 at 11:37 PM Report abuse rate up rate down Reply
BLUEWHITEMARBLE

the money changers in the bluewhitemarble are at risk now. you can only steal,cheat and deceive so much and for that you must come to term with humanity. the temple will clumble once again and no stone will stand firm. thank you

February 14 2011 at 12:11 PM Report abuse +1 rate up rate down Reply
Roberson

If the bank aint gonna lend you money , you are in bad shape. You never borrow money for a wedding. In a ression rebound you work with what you have or postpone. People still have not learned yet . Less is More..............Save Save Save. not spend spend spend ......... It wont be long before Tony's gonna send sombody to collect & gotta break something.................common sense really aint common 13% for loan GTFOH...

See full article from DailyFinance: http://srph.it/gQ6IzH

February 14 2011 at 11:43 AM Report abuse +1 rate up rate down Reply
pj512

Any non-conventional loan scares me a bit. And the couple that borrowed $25,000 because they needed to pay for their wedding tells me what is wrong with them. I've got to wonder how much of their debt was related to that. If you have both lost your jobs, spending a lot of money on a wedding is probably not a good idea. I've been unemployed for over a year now and I've pretty much gone through my 401(K). I rented my house out so I wouldn't lose it and have moved in with my brother. I really hate what is going on right now. Too many people are having to completely change their lifestyles because somebody else screwed up. And I'm talking about the people who bought more house than they could afford on an adjustable rate mortgage and the mortgage companies that panicked and went up on the rates. Thanks!

February 14 2011 at 11:32 AM Report abuse +1 rate up rate down Reply
c141chip

You don't have to borrow anymore. With secretincome4u.com you can build a substantial income starting with only $25.

February 14 2011 at 10:45 AM Report abuse rate up rate down Reply
T REXX

seem's like one of my ex's forgot to change the benefit'pack. on a life ins policy
and i got a 500,000.00 surprize it's true what go's around comes around..her kids aren't to happy..lol

February 14 2011 at 7:37 AM Report abuse rate up rate down Reply
1 reply to T REXX's comment
piknplundr

Good for you! Hope my ex forgets but not likely!

February 14 2011 at 1:44 PM Report abuse rate up rate down Reply
granaryst

Let's get the Federal Government out of the home mortgage business, health care, our schools and everywhere else we don't need them poking their ugly noses into our business. Smaller, controlled government means more freedoms and opportunities for all it's citizens. Big government means more oppression and less freedoms for each and every person to pursue their life dreams and ambitions. The evil, ultra rich want a Mexican style Socialism where they destroy the middle class, so they have all of the wealth and power and everyone else is poor, working for them.

February 14 2011 at 4:05 AM Report abuse +9 rate up rate down Reply
1 reply to granaryst's comment
Joe

Without the federal government over seeing the mortgage business, which they seem to have done that already, the ultra rich you talk about will only get richer at the expense of the poor person getting the loan. Use some common sense. We still need government oversite. That is if we can get them to do their job.

February 14 2011 at 11:24 AM Report abuse +1 rate up rate down Reply
sweepsplay1

The trick is to have a multiple streams of revenue. I am not talking about getting wrapped up in some pyramid scheme or anything like that. There are many businesses you can start yourself with little to no money out of pocket. I started an eBay business 3 years ago that is still running strong today. The peak was profiting around 1400 per month and is currently around 600. That still pays my utilities plus a little. My big hopes are on my other one.

My wife’s company shut down in mid 2008. I was laid off from my job Jan 3, 2009. Of course the first few weeks were a shock and I was on the verge of falling into depression. I pulled myself out of bed one morning with the realization that I really have the opportunity of a lifetime! I have the time to do what I really wanted and enough money coming in to stay afloat while I chased my dreams.

1st I wanted to get into shape. I went for a run and was able to go almost 1/2 mile straight. I kept running and got up to about 3 miles but realized I would never accomplish "getting into shape" unless I set a goal and did whatever it took to achieve it. I decided to set the high goal of running a full 26.2 mile marathon, even though I haven't ever ran a race longer than a 1/2 mile track meet in high school almost 20 years ago. I completed my 1st marathon on Oct. 24th, 2009.

2nd I wanted to start my own business. I had a construction background and little investment money. I decided to go with a sweepstakes directory. I entered some before with some success and thought with as bad as the economy is, I bet a lot of people are looking for a way to get some extra money themselves. A few thousands bucks later my website SweepsPlay went live. I had to go back to work because it doesn't make enough to support us yet, but it is growing. Hopefully in the next year or so my wife and I can be home together again and spend time doing what we love without the stresses of money on our shoulders.

My point is that if you have lost your job, it is tough. I know, I have been there. Just keep your head up. It could be the best thing that ever happened if you take advantage of the opportunity. If you still have your job, even better! Plan ahead in case you lose it. You can't imagine how good it feels to have enough money to live on coming in from 2,3, or even 4 different places! Good luck.

February 13 2011 at 7:59 PM Report abuse +2 rate up rate down Reply
kv37

Don't be surprised if someday you get a letter saying you're not getting your money back.

February 13 2011 at 6:26 PM Report abuse +1 rate up rate down Reply
ultraz2

Now --FINALLY true competition for banks that overcharge their customers with arm and a leg intrest rates.

February 13 2011 at 3:55 PM Report abuse +3 rate up rate down Reply