Borrow from a stranger
Person-to-person lending finds a home online: Folks can make money the way banks do.
Published December 27, 2007
Colin Nash, 35, was struggling with $12,000 in credit card debt late last year. Meanwhile, Michael Fisher, 24, was looking for a new investment. So, Fisher loaned Nash $200.
The men had never met.
Nash and Fisher are members of Prosper.com, the U.S. leader in a growing trend known as peer-to-peer lending, which facilitates loans between strangers.
Social lending has been around since the days when needy families turned to the richest man in town, but the Web is breathing new life into it. Loans on Prosper and Facebook's LendingClub have risen to $100-million this year from $27-million in 2006, says Online Banking Report. By 2010, the report forecasts $1-billion in peer-to-peer loan originations.
"I'm sure banks are watching it," said Jim Bruene, the report's author.
The idea is that borrowers can find better rates than banks offer, while lenders can earn higher returns than from a savings account or other investment.
Borrowers on Prosper post how much money they need - up to $25,000 - the purpose of the loan and what interest rate they can afford. Lenders bid on the loans of their choice, typically funding only partial amounts and diversifying their risk among dozens or hundreds of loans.
Most loan requests are for debt consolidation, followed by small business and entrepreneurial purposes. The average loan amount totals just less than $7,000. Prosper claims it has facilitated $98-million in loans since launching in February 2006.
Prosper's added appeal, however, goes beyond the bottom line. Photos and personal narratives accompany borrowers' requests: A father who needs $25,000 to equip a house and car for his son, who has recently begun using a wheelchair. A young couple seeking $5,000 for their wedding, who plead, "Please help us get married!" A group of young men in Montana who want $1,000 to buy a professional wrestling ring.
The opportunities for social connection appeal to users, said Prosper co-founder and CEO Chris Larsen. Borrowers can appeal to lenders to look past a couple of late payments or spotty credit history, while lenders enjoy the satisfaction of seeing their money help someone in need.
"When you're dealing with people, it's 'I want to do well but I also want to feel good about how I'm doing well,'" said Larsen, who formerly served as CEO and co-founder of financial services company E-LOAN.
But the numbers matter. Each Prosper borrower is assigned a grade based on their credit score to help lenders evaluate their risk and the site verifies borrowers' identities. The average rate of return for lenders is 9.28 percent, with lower-grade loans earning 10.45 percent, according to Prosper.
Prosper makes its money by charging a 1 or 2 percent closing fee, based on the borrower's credit, and lenders pay an annual loan servicing fee of 0.5 to 1 percent. It also collects fees for late payments on behalf of lenders and reports to credit bureaus. After 30 days, a collections agency is assigned to delinquent loans.
"This is not a free lunch," said Greg McBride, senior financial analyst with Bankrate.com. "You have to keep up with these payments just as you would with any other financial obligation."
Prosper's default rate hovers at about 2.7 percent, Larsen said, but that figure is expected to rise as more loans mature.
The market for so-called "friends-and-family" loans is dominated in the United States by Virgin Money USA, formerly a Waltham, Mass., venture called CircleLending. The company, which recently sold a majority stake to billionaire Richard Branson, formalizes loans between family and friends.
For Prosper borrower Colin Nash, loans made it possible for his wife to leave her coffee shop job to care for their children, including a second boy born in mid November. He managed to shave several points off the rates on his credit cards, one of which had reached 24 percent, he said.
"You can't walk into a bank and say, 'Come on, man, I'm one guy and I don't want my wife to have to work,' " Nash said.
Software design engineer Michael Fisher said his decision to lend Nash $400 - $200 for Nash's $12,000 loan late last year and $200 for an $8,000 loan in October - was based on numbers and shared experience.
Since joining Prosper about a year ago, Fisher has loaned out about $15,000. He has 272 active loans. The returns are beating most of his other investments, he said.
"It's just more fun to invest in Prosper, than to, say, invest in stocks," Fisher said. "You're closer to real people."
Virgin Money: www.virginmoneyus.com