Lending peer to peerFrom Kickstarter to Crowdtilt, crowdfunding is all the rage these days as a method for financing large undertakings and projects, especially those of an artistic variety.

But what if instead of convincing others to help you make the next great mumblecore indie film, you could use crowdfunding to deal with something both more mundane and more pressing ... like your credit card debt? After all, it's not just starving artists who could get by with a little help from their friends.

Now, it's unlikely that random people are just going to give you the money to float you through your ordinary fiscal troubles.

But they might make you a loan.

Peer-to-peer lending allows borrowers to bypass the big bad banks and get loans directly from other individuals.

Quite simply, sites like Prosper.com or LendingClub.com work as online marketplaces, connecting would-be borrowers with lenders willing to take a bit of a risk for a good rate of return on their money. On Prosper, for example, borrowers sign up, create a profile and delineate their desired loan; the site verifies the borrower's identity and uses their credit score to assign them a risk rating on a scale from AA (the best) to HR (high risk). Lenders can then consider the borrower's Prosper rating -- with its commensurate interest rate for the loan -- and can offer to make the whole loan, or invest as little as $25 in it. It's simple, and the system is regulated by the SEC.

In our current sluggish economy, the P2P lending trend is understandably in vogue. There's $2.5 trillion in outstanding U.S. consumer debt, with $1.5 trillion of that from credit cards and personal loans. But the nation's consumer credit market is dominated by 10 banks, and those institutions have tightened up their lending criteria, denying credit to many, many people in need of capital. It's often those people who are turning to P2P lending to get money to pay down their higher-interest loans.

As such, P2P lending is experiencing dramatic growth, more than doubling in 2011. Prosper alone saw more than a 178% growth last year. Though it first appeared in the U.S. in 2007, the P2P market is soon expected to exceed $1 billion in loans funded.

A Logical Progression

"Consumer lending is 'I'm just going to charge it on my credit card and pay it back, or get a personal loan," said Joseph Toms, Chief Investment Officer at Prosper. "Both of those options are expensive."

If you can even secure a loan, the interest rate is likely to be high. The rates banks charge for consumer loans -- excluding mortgages, which kept are low thanks to government-sponsored insurance -- averaged 10.92% for a 24-month personal loan at the end of 2011. Credit card interest rates averaged nearly 13%, and can, of course, range much higher.

"Not that debt is bad," Toms said. "But if you take it on, you should do it at a lower interest rate and you should pay it back."



Prosper, which has more than 1,280,000 members in its online community and over $320 million in funded loans to date, offers those more palatable interest rates, which can help people escape the vicious cycle of debt.

Think of it like a social network for loans.

"And it's growing like a weed," Toms said.

Just take, for instance, Lydia Hamilton-Monnie, who wanted to open a women's plus-size boutique in Milwaukee, Wis.: After a frustrating and futile attempt to get a loan from a bank, she turned to Prosper and got a 3-year loan for $25,000, which allowed her to open Boutique Larrieux.

"Banks are not lending to new businesses -- no matter how good you may look on paper -- and that can be very frustrating," she said. "While my business may have been unproven, I had a business plan and a good financial track record, and on Prosper.com, I could let the investors decide to invest. And they did."

Hamilton-Monnie's loan was funded within days as multiple lenders contributed. She bought inventory and display materials, and has been diligent about paying back her loans. She has since expanded to a larger location -- and, having discovered P2P lending, she didn't feel the need to visit a bank for growth funding.

Countless stories like Hamilton-Monnie's are waiting to unfold, and according to expert Sean D. Carr, P2P lending's popularity will only continue to rise because it reduces the barriers to entry into the credit market.

"This emerged during the larger financial crisis, when people are in trouble and they're looking to dig themselves out of debt," said Carr, director of intellectual capital at the Batten Institute, a research center at the University of Virginia's Darden School of Business. "These loans don't require any securitization, any collateral. It makes sense."

Benefits on the Lending Side

On the other side of the equation, the shaky stock market has also given an incentive to investors to dip a toe in the P2P waters. In these risk-averse times, the debt market is a win-win for investors.

"People are scared to death of the stock market, and they need income," Toms said. "Compared to treasury bond yielding 2% or less, we can get you, the investor, 10%," Toms said.

It's true: Lenders are seeing high yields, with average returns of 10.46%. Further, because they can put as little as $25 into a loan, they can diversify and mitigate their risk by building portfolios out of small parts of hundreds or even thousands of loans.

And if, at first blush, making unsecured loans might seem risky, remember that banks have done so for decades and raked in healthy returns, and the P2P lending platforms also have collections processes in place to pursue borrowers if loans aren't repaid.

Signs of Change

Just this month, John Mack, former CEO of Morgan Stanley, joined LendingClub, one of the two major players in the P2P lending arena. This news, along with Prosper's appointment to its board of Eric Schwartz, a former co-head of asset management at Goldman Sachs and member of its management committee, further confirms that P2P lending is poised to go mainstream.

Schwartz was impressed with Prosper's ability to provide industry-leading returns.

"I am excited to be investing in and joining the board of such an innovative company," Schwartz said. "The Prosper.com marketplace is increasingly serving as a mainstream financial instrument for consumers and investors because of the simple value proposition it offers to both sides of the marketplace: access to fairly priced credit and attractive, risk-adjusted investor returns."

Of course, as attractive as the sector appears, it's worth remembering that it was a financial crisis that give rise to it in the first place.

"It's really important in a very big picture sense that out of chaos comes new trends and opportunities," Toms said. "2008 was the greatest crisis we've experiences since the [Great] Depression, and had to ask, 'Is there a better way?' We're very ingenious. Crowdfunding has become an effective competitor to banks. That's an exciting long term trend. Really keep your eye on this -- it's not a flash in the pan."

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Dave Facell

Don't be fooled.

http://badmoneyadvice.com/2010/01/is-prosper-com-a-good-investment.html

May 06 2012 at 11:07 AM Report abuse rate up rate down Reply
debbie

That's "NEITHER a borrower nor a lender be!" And there's a good reason for that. In that same sermon it says that if you loan somebody money, consider it a gift and don't mention it to the person again because you will probably never get it back.

May 02 2012 at 9:53 AM Report abuse +1 rate up rate down Reply
Nat. Family Mortgage

This is a great article, Ross. LendingClub and Prosper are pioneering an exciting space, but it's also worth mentioning there's a "direct p2p lending" movement going on as well. National Family Mortgage helps folks properly structure, document, and register tax-deductible mortgage loans between relatives. From down payment and home home improvement loans to 100% financing or refinancing, National Family Mortgage helps families build wealth, reduce IRS tax problems, protect relationships, and keep money in the family. While LendingClub/Prosper Lenders earn yields upwards of 10%, National Family Mortgage interest rates average 3.50% over 23 year terms. Intrafamily loans can be a great solution for the right families in the right situation. Peter Renton is right -- 2012 is definitely shaping as a breakout year for p2p lending!

May 01 2012 at 6:33 PM Report abuse rate up rate down Reply
Peter Renton

I think that 2012 is shaping as a breakout year for p2p lending. With news that prominent people in financial services are coming on board and the growth that is continuing more mainstream investors are look to Lending Club and Prosper. In this low interest rate environment there is very little opportunity to earn decent returns - p2p lending provides that opportunity.

May 01 2012 at 4:42 PM Report abuse -1 rate up rate down Reply
Gregory Linden

Banks best beware. After jacking up rates and denying credit when Americans needed it most, they've paved the way for a new model of finance. The word is out and people will flock to borrow (and invest) from each other. http://debtandburied.com/2012/04/30/prosper/

May 01 2012 at 12:56 PM Report abuse rate up rate down Reply