If you’ve spent much time on the Internet and on personal finance sites in particular, you’ve probably heard of Prosper and peer-to-peer lending. Just for review, what is peer-to-peer (P2P) lending? It’s basically connecting those with money to invest with those who wish to borrow – cutting out the middle-man (usually banks) in the process. With sites like Prosper and Lending Club, borrowers can borrow at much lower rates and investors can achieve much higher rates than at traditional banking institutions. Believe it or not, BILLIONS of dollars have been invested and borrowed through peer-to-peer sites like Prosper. Yes, billions!
In fact, Prosper has seen 370% year-on-year growth in their business last year, lending over $70 million last year alone bringing their total lending to day of more than $260 million. And they did it with a default rate of around 5.2%, compared to Bank of America whose default rate on credit cards has been at an annualized basis of around 5.98%.
In fact, paying off high interest credit cards is the most common use of funds by P2P borrowers. Others have used sites like Prosper and Lending Club to:
- Consolidate bills
- Pay medical bills
- Pay for a wedding
- Pay for a vacation
- Buy a vehicle
- Cover adoption expenses
- Pay for home improvements
- Even business loans
Investors, well they’re generally interested in getting one thing: a better rate of return than what’s offered by most banks. But that’s really selling some investors short. Many are genuinely interested in P2P lending as a way to better help their fellow man (or woman). Additionally, you’re able to open retirement accounts (think IRAs) using P2P sites like Prosper and Lending Club!
P2P lending and the risk factor
If you choose to believe the disinformation from most of the establishment (banks), P2P investing is too risky and is more akin to payday lenders or pawn shops. P2P lending according to them, only provides opportunistic financing to weak credit borrowers who can’t get a loan anywhere else.
Nope. Not at all.
The credit score of the average borrower on Prosper is better than you’d believe and the profile of the average lender in a P2P transaction is just someone who wants a better return than the measly interest rates offered at most banks. Simple as that.
P2P financial transactions serve to simple connect borrowers and lenders with as little middle-man interference as possible.
P2P financial transactions can offer low rates in comparison to their traditional banking competitors because P2P sites focus only on a select subset of customers – the most credit worthy borrowers – and fair pricing is commensurate with the risk. Borrowers get lower rates than they would be offered at a bank while investors get higher rates than they would get at that same bank.
The P2P lenders have also done considerable work on understanding the behavior of their investors (lenders), which means they don’t look just at the credit score or borrowers since it’s a lagging indicator of a default risk. P2P lending sites also look at the future likelihood of a default, examine. P2P sites like Prosper claim that their lower default rates are the result of using better credit modeling, looking at overall indebtedness and affordability, not just the credit score. It’s these better credit models that are helping P2P lending and investing to thrive.
Are there any negatives with P2P?
Yes, the main one is that only 27 states allow investors to participate and some have stringent (ridiculous) requirements for anyone wishing to earn that better rate (see Prosper or Lending Club for more details).
Another negative aspect is that investors are much closer to borrowers than in traditional banks. You probably never had any idea about the default rate at your traditional bank and as a result, you were removed from it’s effects. With P2P lending you actually see how a default affects your returns and it’s much more real.
P2P grows up
In US some P2P sites are even encountering more sophisticated investors expressing a desire to participate in P2P transactions, meaning that there will be an abundance of cash to support the demand for P2P credit. In fact, the major P2P players in the US are seeing institutional investors, high-net worth investors and the like looking to put cash into P2P. These institutional investors aren’t just trying to get a higher deposit rate, but to get a higher rate with only marginally greater risk – if any additional risk at all.
Players like Prosper are anticipating their largest year yet. In fact, this year is likely to be larger than the past few year’s lending seasons put together for the P2P market. If anyone had any remaining doubts about the viability of P2P lending, then I think those fears can be put that to bed.