Editor's note: Not drowning in debt? Have $1,000 to put to work? TheStreet.com senior correspondent and You're So Money author Farnoosh Torabi looks at peer-to-peer lending.
This week I'm giving my $1,000 to a complete stranger on the Internet.
No, I'm not answering one of the few dozen Nigerian money transfer pleas I receive each week in my Spam inbox. Instead, I'm heading to a peer-to-peer (or "P2P") lending Website -- like Prosper (prosper.com), Lending Club (lendingclub.com) or Zopa (zopa.com) -- where I understand folks can earn much more on their investments than the current average of three percent that banks are offering on various savings vehicles, such as
and savings accounts.
P2P finance connects individual borrowers -- of various credit standings -- seeking everyday loans, without the pricey interest rates at traditional banks with borrowers looking to get more bang for their investible buck.
As the credit market continues to tighten and the Internet becomes more of an accepted platform for financial transactions, the P2P lending industry is expected to flourish over the next few years. Research firm Celent expects the overall P2P market to gallop 800% from now through 2010, reaching $5.8 billion in peer-to-peer loans.
Take established San Francisco-based Prosper.com, the country's biggest P2P lending site, which recorded $28.9 million in funded loans year-to-date (YTD). That's up slightly from $28.3 million YTD 2007. The number of loans is also higher, growing from 4,145 YTD 2007 to 4,379 YTD 2008. "With the
lowering rates it is now pretty straightforward
to use P2P lending. With portfolio planning you can expect a five to 10 percent
return," says Chris Larsen, the CEO and founder of Prosper.
What You Need to Know
Generally speaking, before you decide to lend at a certain interest rate, online P2P lending involves scouring through listed borrowers, examining their credit standings, why they need the money (whether it's to pay for a wedding, pay for school, start a flower shop, or any number of other reasons) and how much they seek.
Interest is typically received each month and there are generally no fees for lenders, though the sites do differ in some lending/borrowing models. Here's a rundown of the main P2P lending Web portals.
Lenders search through loan listings and bid for various loan requests by stating how much interest they would be willing to pay the borrower. Think
. The minimum loan is $50. The site boasts an average return rate of 8% for "prime loans," where borrowers have grade-A credit.
This site works more like Match.com
, where the site itself hooks up borrowers and lenders based on certain criteria like how much debt the borrower wants to take on and how much financial risk the lender can stomach. The site refers to itself as a "social lending network" and to that end has even started integrating itself on social networking site Facebook. Lending Club's current average rate performance is around 12%.
Unfortunately, new lenders are on stand-by at LendingClub.com. The site says it's working out "details" with the
and isn't accepting individual loans at the moment. Instead, the site is funding borrowers itself.
One of the newest entrants to the P2P lending market in the U.S, Zopa, first launched in the U.K. in 2005. The global P2P site has a fixed rate of return for investors through its "Zopa CDs." Think traditional bank CDs, with tad higher interest rates than the average 3.0% or so most banks offer these days. For example, a 12-month CD at
currently earns you roughly 2.87%. At
it's 2.81% for a 12-month online CD.
Zopa.com pools together deposits (minimum $500) from various investors to help fund borrowers. At present, investors receive a guaranteed 3.75% rate of return. The fixed 12-month rate has been lowered twice since the U.S. site's December launch, going from 5.1% to 4.5% to the current 3.75% rate.
"We look at the prevailing rates that financial institutions are offering on their CDs...our goal is to have a stronger return," says Chris Strausser, Chief Marketing Officer at Zopa USA.
So how do P2P lending sites beat the traditional banks?
For one, P2P sites are virtual, which means an automatic savings on overhead that traditional brick and mortar banks need to afford. Also, there are no "loan officers," since P2P bank sites offer a direct network for borrowers and investors. Most P2P sites also charge borrowers an upfront fee based on their credit standings. There may also be a processing fee and/or a "delinquency" fee for failing to pay up.
The major P2P sites vow to screen borrowers. At Prosper.com, borrowers are ranked on credit-worthiness and listed with their credit grade. LendingClub.com and Zopa.com do not accept borrowers with any delinquencies on their credit histories that date back 12 months and they must have credit scores of at least 640 to participate. Usually, the higher the borrower's credit rating, the less chance of
default. But, as a lender, if you're feeling lucky, you may want to go for riskier borrowers (think "subprime"), since you can expect higher rates of return.
That said, loans and their interest rate returns at Prosper and Lending Club are generally not insured or even guaranteed with default protection like a savings account would be at the local bank (up to $100,000 by the FDIC). The only sense of comfort is the knowledge that the P2P agent will report any missed payments or defaults to the credit agencies -- just like a credit card company reports delinquencies. The result: a stinky credit report that will hurt the borrower in the future.
The one added embarrassment for bad borrowers is the social shame of failing to hold up their end of the bargain. After all, failure to pay will be disclosed on the Internet. But that doesn't necessarily deter borrowers from bowing out of a deal. "The lender is taking on risk just like any other
asset class," says Larsen. "If the borrower defaults the risk is going to the lender."
At Zopa, though, its fixed-rate loans of up to $100,000 do have backing, since the site has partnered up with
and is insured by the
National Credit Union Administration.
P2P Lending: A Winning Strategy
As a result of the potential risks, it's extremely important and highly recommended by the P2P lending sites to scatter your money throughout numerous loans of various denominations. In other words, I'll be spreading my $1,000 to at least 10 different borrowers, with the goal of adding more money in the future and further diffusing my investments through more loans.
And If You're Feeling Charitable...
While there's no monetary return on investment through Kiva (kiva.org), the site works like a P2P lending portal that connects small business owners in generally impoverished countries with lenders, who act more on a philanthropic than financial desire -- since there's no interest...yet.
"We do desire...to offer a nominal interest rate to our lenders," says Kiva spokesperson Fiona Ramsey. For now though, Kiva is just a social cause -- and a great one at that.
Kiva vows to help fight poverty in developing countries where residents have little to no access to debt financing. Micro-financing channels like Kiva empower budding entrepreneurs across the world. "
Lenders can actually see the person they are lending to. There's a personal connection," says Ramsey. Each loan at Kiva has a different term. On average, repayment to the lender is made in 12 months. The average loan is about $500.
Ways to Play $1K
put a thousand bucks (or less) to smart use?
Please email me your suggestions at
Farnoosh Torabi joined TheStreet.com TV in July 2006 as the site's first official video correspondent. Previously, Farnoosh was a business producer and on-air reporter for NY1 News, Time Warner's 24-hour news channel in New York City. Farnoosh is a regular columnist for AM New York and has written for Money, Time, New York Daily News and Newsday. Farnoosh is a graduate of Pennsylvania State University, with a degree in Finance and International Business and holds a M.A. from the Columbia School of Journalism.