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More Borrowers Are Discovering 'Social' Lending

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The Tampa Tribune

Published: January 20, 2008

In the wake of the subprime mortgage meltdown, traditional financial institutions have tightened up on who gets to borrow. But some people are still finding ways to get the money they need through another area of lending that is booming.

Person-to-person lending, or "social" lending, is growing at a phenomenal pace on the Internet as consumers look for an alternate way to pay off debt, according to research by Javelin Strategy & Research. Javelin predicts that the demand for person-to-person lending services, or P2P, to pay off credit-card debt may grow from $38 billion to $159 billion over the next five years.

But while many people see opportunities to get cash that might not otherwise be available to them - and lenders see a way to deploy some of their extra cash - participants in this emerging form of lending should heed several caveats.

Repair Or Purchase?

I understand the appeal of utilizing the services of such companies. Often, especially in the current lending market, it's hard - if not impossible - to get small unsecured loans.

I frequently joke that many people buy new cars not because they want one but because they can't borrow the $1,500 they need to fix their current vehicle. It's easier to borrow $20,000 for a car than $1,500 to fix one.

One company seeking to fill the gaps in the private arena is Prosper, an online loan auction site. Prosper works much like eBay, the online auction site, except instead of people listing consumer items, what's being brokered are consumer and business loans. People who need a loan create a listing for up to $25,000 and set the maximum rate they are willing to pay a lender. People who register as a lender set the minimum interest rate they are willing to earn and bid in increments of $50 to $25,000 on listed loans. Once the auction ends, Prosper takes the bids with the lowest rates and combines them into one loan to the borrower. The company handles all the administration of the loans, including the repayments and, in the case of a default, collection actions.

For its part in the P2P lending, Proper charges a 1 percent to 3 percent loan closing fee.

Most recently, Richard Branson's investment firm acquired a majority ownership stake in CircleLending. Branson is the founder and chairman of the Virgin Group. CircleLending has been rebranded Virgin Money USA.

Virgin's business model differs from Prosper in that it helps manage loans only between family and friends. Starting at $99, the company will help put together a promissory note and payment schedule. For additional fees, the company will set up automatic payments, record a lien and service the loan.

Why Turn To P2Ps?

The top reason consumers said they would use a P2P loan is to get a better interest rate. In Javelin's survey, 36 percent of borrowers said they used the service for the better interest rate. Some (33 percent) have turned to P2Ps to avoid using credit cards. Others (27 percent) go that route because they do not qualify for a loan from a bank or credit union.

Higher-income and younger consumers are the most active users, but Javelin is predicting the appeal will widen as the social lending opportunities increase.

Clearly, borrowers benefit from this social lending trend. They can formalize lending agreements and often get a rate better than at a financial institution or pay off higher-interest credit-card debt. For lenders, they too get a better rate than they might get depositing money in a high-yield checking or savings account.

However, "for lenders there is always the issue of default. Will someone get paid back," says Jean Garascia, an associate analyst with Javelin and author of its report.

Even with documentation, the default rate is higher than that with financial institutions.

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