P2P Lending: Borrowing Beyond The Bank

peer lending

Mitt Romney caught a lot of flak recently when he said that young Americans should simply “borrow money from their parents” to start a business. The obvious implication was that Romney believes everyone’s parents are as rich as his, and that accessing unlimited money is as easy as making a phone call home. We can all agree that borrowing money isn’t that easy and that parents aren’t the go-to financing option for all of us—but what are our options outside the bank? When can we borrow from people, be they friends and family or unknown investors?

There are several potential advantages to getting a loan from a peer-to-peer platform. Loans from services like Prosper and LendingClub can sometimes be used to manage high-interest credit card debt. Borrowers take out a loan from these sites at a lower interest rate, and use it to pay off the rapidly accumulating credit card debt. Other peer-to-peer sites let you do what Romney advises we all do: borrow money from our parents or relatives. The sites help by formalizing and legalizing the arrangement, meaning that parental borrowing doesn’t have to include awkward conversations or fights over late payments.

Peer-to-peer lending gained a lot of traction after the financial crisis of 2008 and the ensuing credit squeeze. Credit standards were tightening, and the publicity around the risky loans made during the housing bubble made getting a non-bank loan a popular choice. Prosper, Lending Club, Zopa and Loanio all increased lending 50% year-over-year from 2007 to 2008, according to news reports (Zopa is now U.K. only, and Loanio ceased operation in 2011).

But interestingly enough, what many people think of as peer-to-peer lending sites are now often brokering loans between individuals and the same types of risk-seeking institutional investors that bought up subprime products during their heyday.

All the loans made on both Prosper and LendingClub, two online lending platforms often referred to as peer-to-peer, are made by Utah-based WebBank. Prosper and LendingClub then sell off pieces of WebBank’s loans to investors—those investors might be what you would think of as peers, meaning they are individual people who want to invest in your loan, or they might be hedge funds, pension funds or RIAs. A recent article in the Wall Street Journal cited the high interest rates on what Prosper/LendingClub designate as “riskier” debt as attracting these institutional players, who are always hunting for higher yielding investments.

But that isn’t a necessarily a bad thing. Peter Renton, of the peer-to-peer blog SocialLending.net, said he thinks the presence of big investors translates into a vote of confidence in legitimacy of the platforms. “I believe it is a good thing. Actually, I will go further than that. I would say if this wasn’t happening it would be a bad sign for peer-to-peer lending. You can’t publicize average returns of 10% and not expect the big money players to come to the table,” Renton wrote on his blog in 2011.

On the other end of the spectrum, however, some lending sites exist purely to facilitate loans between people who actually know each other. Timothy Burke, CEO of National Family Mortgage, said he thinks it’s important to remember the difference between all the platforms that fall under the peer-to-peer umbrella. “National Family Mortgage is facilitating true peer-to-peer mortgage loans, generally between relatives,” Burke said. “We never handle the disbursement of the loans –we help properly document the transaction and help manage the repayment process to protect relationships and provide year-end tax records.”

“Peer-to-peer lending is still a very young space,” Burke added. “And all things considered, I think Prosper and Lending Club are great companies. The challenge for all of us is differentiating our product lines and educating consumers without confusing them!”

With that in mind, below is a comparison of eight non-bank lending sites:

Offers fundraising, crowdsourcing and/or lending from unknown investors Are there fees? If so, who pays: borrower or lender? Are loans reported to credit agencies? Tools offered to manage loan and payment process? Can you prepay the loan without penalties? Does the platform support secured and unsecured loans? Notes/Other features:
LendFriend Focuses on connecting borrowers and lenders with a preexisting relationship. Allows for Facebook fundraising. No N/A No Yes, offers free documenting and loan management tools Yes Unsecured
LendingClub Yes — loans are made by WebBank, then financed by investor pool (retail and institutional). There’s a one-time fee to set up the loan Borrower Yes – LendingClub files a monthly report with credit bureaus. No. According to LendingClub, 99.9% of their borrowers use ACH payments from their checking accounts to automate the repayment process. Yes Unsecured
LendingKarma No — helps facilitate loans between people who know each other. Users pay a one-time fee (Basic or Premium) to set up the loan. Either No Offers a payment tracker service and can send out payment notices to borrowers Yes Both Partners with LendingClub
LoanBack No — helps facilitate loans between people who know each other. One-time fees to set up loan ($14.95 for loan forms, and $29.95 for LoanBuilder tracking tool), and loans can be customized to include late payment fees. Either No Optional upgrade to use LoanBuilder tool. Offers interested calculation, payment schedule generator, etc. Loans can be customized to include prepayment, or fees or early repayment Both
National Family Mortgage No — helps facilitate loans between people who know each other. Set up fee of $599, optional loan servicing costs $15/month for loans up to $600,000 Borrower Not yet — NFM is working on a protocol with TransUnion and should begin reporting within six months Optional servicing feature, tax reporting, payment schedules, payment reminds, escrow Yes. Mortgages, secured by homes, only.
Nolo No — helps facilitate loans between people who know each other. Forms are available for purchase Either No No Loan terms are decided upon by lender-borrowers Both Nolo offers a very basic DIY approach for lending, via selling promissory notes templates and related paperwork that borrowers and lenders can use themselves.
Prosper Yes — loans are made by WebBank, then financed by investor pool (retail and institutional). Borrower pays a closing fee if their loan is funded. The closing fee is a percentage of the loan amount, varying by Prosper Rating. Investors pay an annual servicer fee, which is currently equal to 1% of the outstanding principal balance of the corresponding borrower loan. Borrower and lender If a borrower loan request is funded, a credit inquiry will be posted to the borrower’s credit report Prosper loans are set up for monthly payments to be automatically deducted from a bank account on file. Prosper also sends an email reminder to the borrower one week before the scheduled payment is due. Yes Unsecured Markets non-traditional loans, like adoption loans, engagement ring financing and loans for sustainable home improvement.
ZimpleMoney No — helps facilitate loans between people who know each other. Yes — fees vary by plan Borrower or lender No, unless customers have an excess of 200 loans active per month. Automated billing and collection, automated payment alerts, automated account posting, funds automatically deposited — vary by plan. Also offers a platform for crowdsourcing companies to manage and automate loan payments. Yes Both

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