With banks tightening their lending standards and credit card companies raising interest rates, borrowers are increasingly turning to an unusual source of money: other people.
Despite a recent regulatory hurdle, websites that facilitate peer-to-peer lending, in which people--often strangers -- lend money to each other with no involvement from a bank, are growing in popularity. Borrowers usually get loans with lower rates than they would from banks or credit cards, while investors often get higher returns than they would from traditional bank products such as certificates of deposit.
Analysts expect the industry to grow as customers who face rising credit card rates search for new ways to refinance their debt. Many investors, meanwhile, have lost confidence in the rocky stock market and have sought other places to park their cash. Membership in peer-to-peer lending groups is climbing fast, and so is the money involved. About $282 million US in peer-to-peer loans were made in 2006, according to Celent, a Bostonbased research firm. By 2010, the firm expects such loans to grow to $5.8 billion.
The industry has gained so many followers that the U. S. Securities and Exchange Commission last year ruled that companies engaging in peer-to-peer lending must register with the agency because the loans are considered securities. After temporarily suspending their operations for several months, Prosper and Lending Club completed its registrations. Loanio and IOU Central have filed their papers, an SEC spokesman said. Others are expected to follow.
"With this credit crunch, the timing couldn't have been better for this industry to really gain a foothold and grow," said Curtis Arnold, founder of CardRatings.com and co-author of the Complete Idiot's Guide to Person-to-Person Lending. "It offers a viable option for folks who are getting turned down for credit elsewhere. There's a lot of people fed up with banks. From the investment side, that is intriguing. When you can get nine to 10 per cent returns in this market . . . that's pretty amazing." Since registering with the SEC in October, Lending Club has gained 300,000 members. In January, it oversaw$1.8 million in loans. Last month, $3.4 million in loans were made.
Between the time it launched in 2006 and registered with the SEC in July, Prosper has grown to 850,000 members and facilitated $180 million in loans.
Officials at the lending sites said much of their increased traffic has come from borrowers whose interest rates on their credit cards have spiked. Card issuers have been raising rates in anticipation of a new law, set to take effect in February, that could hinder rate increases. During the housing boom, many consumers were able to get out of their card debt through home-equity lines of credit. But home values have plummeted in many areas, leaving borrowers without a source of money they once fell back on. About 50 per cent of Prosper's loans go to borrowers trying to consolidate credit card debt, said Chris Larsen, Prosper's chief executive. Prosper's loans can come with interest rates as low as four per cent. "With their credit card debt, it could take 20 years to pay it off," Larsen said.
Other peer-to-peer lending sites operate differently. Prosper allows lenders to bid on the interest rates for borrowers, which results in low-rate loans. Virgin Money codifies loans between friends and families. Other companies specialize in particular types of loans. TuitionU, for example, helps students get loans to pay for school.
The sites typically vet borrowers by pulling their credit reports and requiring minimum credit scores. But the loans do not come without risk. Lending Club's borrowers have a default rate of about three per cent. Prosper's default rate is about five per cent. If a borrower misses payments, the sites report him to credit bureaus. Officials at the sites point out that credit card default rates are in the double digits.
Still, Mark Schwanhausser, a research analyst at California-based Javelin Strategy and Research who has studied peer-to-peer lending sites, said investors should be vigilant for signs that borrowers are struggling to repay their loans.
"It's not a 'buy it and tuck it away' kind of thing," he said. "I think you want to pay attention."
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