Online Person-to-Person Lending

 

Kevin Gillet
Consultant
RateLadder
www.rateladder.com/

 

Online person-to-person lending (also known as peer-to-peer lending or P2P lending) is a modern twist on borrowing that has roots as old as money itself--people borrowing money from other people as opposed to large conglomerate banks. 

 

People connecting online has become commonplace--you can e-mail, send instant message, share pictures, blog, bank, pay bills, and even twitter over the Internet. Online P2P lending is an outcome of this unprecedented connectivity.

 

With online P2P lending--as opposed to a traditional bank loan--both the borrower and lenders are regular people, and the transaction is enabled via the P2P lending company.

 

When a P2P loan is consummated, the borrower receives the funds (minus any fees). Loan repayments (principal and interest minus fees) are distributed to the lenders based on the lenders' pro-rata share of the loan principal. If the borrower becomes delinquent, the P2P lending company will initiate various collection practices such as reporting the delinquency to credit agencies and authorizing a collection company. If the loan becomes delinquent to the point of charge-off, it is sold to a junk debt buyer.

 

P2P lending provides borrowers with new access to credit, and the interest rates of a P2P loan are generally lower than what banks offer.

 

P2P lending is either a new asset class or a simple certificate of deposit (CD). At the time of this writing, there are two P2P companies operating in the United States and open to individual lenders: Prosper (www.prosper.com/) and Zopa (http://us.zopa.com/). 

 

Prosper has a reverse Dutch auction model. When a borrower is qualified and creates a listing, the listing has an initial starting rate. Once the listing is fully funded, each new bid by a lender must be at a rate lower than the previous rate. When the auction closes, all the lenders receive the listing's final rate. For the highest-quality listings, it is not uncommon to see a 4% to 5% drop from the starting rate. Typical rates on Prosper range from 7.56% to 29.5%, depending on loan size and credit grade. All loans are unsecured, and if a borrower goes into bankruptcy or charge-off, it is possible that the lenders will lose the entire principal balance of the loan.

 

Zopa provides a National Credit Union Association-guaranteed CD from its partner credit unions (3.75% at the time of this writing). The credit unions use the CD funds to invest in loans. Lenders can offer borrowers a small portion of their CD interest.

 

With the credit crunch making it more difficult for small business owners and entrepreneurs to secure traditional loans, perhaps it's time to check out the world of P2P lending.