Need to borrow some money? Going to the bank or using your credit card could be among your choices, even asking a friend or your Aunt Sally, but peer-to-peer lending is one option that has gained popularity over the last several years for those who need a loan. The bank crisis has caused a rippling effect throughout the economy in terms of housing and borrowing ability. Peer-to-peer borrowing is increasingly prevalent with more people joining social networks and getting involved with lending clubs across the country. (Learn more in Peer-To-Peer Lending Breaks Down Financial Borders.)
Peer-to-peer lending occurs when investors looking for a place to park their money and gain interest come together with borrowers looking for loans that are so small that banks do not want to bother with them. Also, banks charge such a high interest rate that it is not feasible for certain borrowers. Lending sites such as Lending Club specialize in these types of loans. The loans can be used for anything from a baby on the way, a car, a home, student loans or to cover medical bills.
Lending Club History
The site started as an application on Facebook in 2007, and shortly after the company launched its own website. It has become popular as a result of the lending options it offers to borrowers with different credit backgrounds. Similar to normal loans from banks, borrowers who have a good credit score can expect to pay a lower interest rates. And borrowers whose credit background is not exceptional can expect to pay higher interest rates. The site facilitates the selling of loans in the form of notes called a Member Payment Dependant Note issued by the Lending Club. The unsecured notes are registered with the Securities Exchange Commission (SEC) and serve as the loan to borrowers.. There is typically a service charge of 1% for lenders when they make a loan which reduces the yield on the interest of the note. The service charge is a fee for servicing the loan.
Fees imposed by the site on borrowers vary depending on their creditworthiness. Information on credit history and credit scores is provided to the site by a consumer-reporting agency. In order to categorize borrowers, borrowers receive a "loan grade" from the site that is based on the information provided by the agency. The loan grade is then used to determine how much in processing fees a borrower will be responsible for paying and the interest they will pay on their loans. Any delinquencies towards loan payments will add considerable late charges.
Lender and Borrower Requirements
There are certain requirements lenders need to meet if they want to lend money. Lenders have to be a resident of one of the states listed on the site, have an annual gross income of at least $70,000 and a net worth of at least $70,000 excluding home, home furnishings and automobiles, or have a net worth of at least $250,000 with the same exclusions. Residents of California need to have an annual gross income of at least $100,000 and a net worth of $100,000 with the same exclusions or a net worth of at least $250,000. Also, the site restricts individual lenders from making loans of more than 10% of their net worth.
Borrowers of Lending Club need to have a FICO credit score of 660, a debt-to-income ratio under 25% and a credit profile without current delinquencies or recent bankruptcies. Interest rates on these loans vary depending on the loan grade assigned to the borrower. Loan amounts range from $1,000 to $25,000. To protect themselves and lenders, the majority of lending sites rely on consumer reporting agencies and antifraud and identity databases to verify names and social security numbers. (Think you have been a victim of identity theft? Read Identity Theft: What To Do If It Happens to learn the steps to reclaim your identity.)
Other Lending Sites
With the increased demand, there are more lending sites popping up. Prosper.com, for example, requires that borrowers have a minimum FICO score of 640. They offer three-year loans with no prepayment penalties and borrowers can take up to two loan amounts at a time. Some websites restrict borrowers to just one loan. Zopa.com is another social financing company. This company is a bit different than the other lending sites in that it is teamed up with several credit unions. Once a loan rate is determined by this site for its borrowers, the borrower can choose to lower his or her interest rate if others pledge to borrow CDs by participating credit unions against that loan. Kiva.org is another peer-to-peer lending site. This one focuses on facilitating loans between very low-income entrepreneurs in developing countries and lenders. Loan duration is six months to one year. Once the entrepreneurs recoup the loan amount through their business, the loan is paid back to lenders; however, no interest is earned on loans made to Kiva.
(Learn more about microfinance in our article Microfinance Has Major Impact.)
Bottom Line for Borrowers and Lenders
Squeamish investors take heed when investing in interest-gaining loans. If a borrower defaults on a loan, you will lose the money you invested. The company facilitating the transaction will not be responsible for payment of the loan. This type of investment is also not FDIC insured. If a borrower does not pay and collection is initiated by the company on the delinquent loan, the company will first collect 30-35% in fees and then pay lenders the difference. This will decrease the value of the initial loan amount in which the lender has invested.
These loans are unsecured and highly risky, and information obtained from the consumer reporting agencies only help to a certain extent. The data provided by these agencies might not be up to date in reflecting the borrowers' actual creditworthiness or the information provided to the lending sites could sometimes be inaccurate or intentionally false, so be careful. Companies like Lending Club have had cases where identity fraud was involved.
In these cases, they implemented the limited Identity Fraud Reimbursement Program. Through this program, a portion of the loan was been paid back, but only in a limited number of specific cases. Don't go into this type of investment if you will not be able to afford a loss should the borrower not pay back the loan. Do thorough research before you engage in any transaction and be sure to weigh all of your options.
Learn more in 7 Unconventional Ways Businesses Can Borrow Money.