Despite all the recent talk of recovery, getting a loan -- for college, debt consolidation, home improvements -- is still more difficult than it used to be. A recent analysis by the Wall Street Journal found that the amount of loans held by 15 large U.S. banks was down 2.8 percent in the second quarter of this year, and the majority of loan volume in April and May was for mortgage refinancing and renewal of credit to businesses -- in other words, not new loans.
Simultaneously, we're also earning less interest on any short-term savings we've managed to stash away, whether in a money market or a CD. As I write this, one-year certificate of deposit rates are averaging 1.6 percent, down from 3.63 percnt this time last year. Money-market accounts have dropped from 2.5 percent a year ago to 1.2 percent now, according to Bankrate.com.
So some borrowers are turning to a somewhat newfangled solution. It's called peer-to-peer (P2P for short) lending. It's a practice of allowing individuals to borrow money from and lend money to other individuals, generally over the Internet. And this phenomenon is becoming quite popular. The financial research company Celent has predicted that we'll see more than $5 billion in these kinds of loans by 2010, up from less than $300 million in 2006.
There are a lot of advantages associated with P2P lending, including low interest rates for borrowers and high returns for lenders. Below is a primer for stepping into this market.
If you want to borrow:
How it works. You go to a P2P Web site and post the amount you need to borrow. Lenders then bid by interest rate to fund your loan. The two leaders in the marketplace, Prosper.com and LendingClub.com will both allow you to borrow as much as $25,000 at a time at a fixed rate, and give you three years to repay the funds. It's important to understand there are closing costs involved of around 3 percent. That's a key consideration. Right now, according to Prosper CEO Chris Larsen, most borrowers are using the site to consolidate unsecured debt, i.e. credit card debt. The closing costs to refinance $10,000 in credit card debt would be $300. You need to be sure you're gaining at least that much back (and preferably substantially more) in interest rate reductions before you initiate the deal.
Credit scores still count. While you might think that the due diligence for borrowing this way would be slim to none, it's not. This isn't an easy way out for someone with a bad credit history. LendingClub.com and Prosper.com, the two leading sites in the marketplace, require borrowers to have a minimum credit score of 660 and 640 respectively. And, as with traditional loans, the lower your score, the more you pay, and if you default or pay late the information will end up on your credit report.
Consider borrowing from family and friends. Another player in the P2P market to have on your radar is VirginMoney.com. Rather than putting your debt out for competing bids, it's a facilitator that allows you to borrow from friends or family, but handles the transaction in a businesslike manner. For a fee of $99 to $199, depending on the level of service you choose, this site will draw up a contract and a repayment schedule for personal, student, business or real estate loans. You and your lender get to decide whether there will be interest involved and if so, how much and whether you want the loan to show up on your Experian and TransUnion credit reports. In this way, repaying a loan to a family member can be a good way to jump-start your credit history.
If you want to lend:
Do your research. You don't need to be a credit expert, but you should have a good grasp of what separates a good score from a bad, and how the borrower's debt-to-credit ratio factors into the equation, says Curtis Arnold author of "The Complete Idiot's Guide to Person-to-Person Lending." Why? Because when you are a P2P lender, it's you -- rather than a bank -- deciding who is worthy of a loan and who isn't. I suggest going to myFICO.com, the Web site for the Fair Isaac Corporation, which crunches the numbers for credit scores. They have a simple explanation of what goes into a score -- something you should understand for your own purposes regardless of whether you decide to get into the P2P game.
Start small -- and broad, for that matter. "You don't have to make a $5,000 loan to a single person; you can make very small loans and spread your money around to hundreds of people. That's exactly what banks do to spread their risk," says Larsen. That way, if one person defaults, you won't lose your entire investment. Dip a toe in the water, see what you think, and then consider making bigger loans.
Diversify, diversify, diversify. With analysts worried that the soaring stock market may be nearing the end of its current climb, the returns on investment posted by P2P sites look pretty attractive. Prosper's return is an average 7.06 percent, Lending Club's 9.62 percent -- but that's in no way a guarantee. In particular, understand that while long-term performance is the best barometer of future results, this is such a new market that long-term results simply don't exist yet. That's why even fans say it should represent only a small slice of your asset allocation. "Peer-to-peer lending should be a small part of your overall investment scheme. Don't put all your eggs in one basket," says Arnold. "The temptation is to chase that 9.6 percent return, but past performance doesn't guarantee future performance."
Finally, whether you're borrowing or lending, do your Web site homework. "When you have a growth phase like we're in right now, you're going to run into bad apples," says Arnold. You're going to see a lot of small sites pop up over night, and that doesn't mean they're reputable. Make sure you find out the differences, understand the fee structures, and look for the best service for you.
With reporting by Arielle McGowen
Jean Chatzky is the financial editor for NBC's "Today," a contributing editor for More magazine, and a contributor to "The Oprah Winfrey Show." She is the author of six books, including the book The Difference: How Anyone Can Prosper in Even the Toughest Times (Crown, March 10, 2009). To find out more and to read her blog, visit her Web site, www.jeanchatzky.com
