Peer-to-peer lending is a shining example of how technology can disrupt market dynamics by facilitating exchange and introducing greater efficiency. Peer-to-peer lending allows participants to bypass traditional banks and financial institutions, allowing borrowers with poor or no credit to receive loans, and offering individual investors acting as lenders access to impressive returns. Web-based intermediaries evaluate borrowers, assign credit ratings and match them to lenders. Lenders can often designate the level of risk they would like to assume, with returns adjusting accordingly.
Q. So you’re saying this is the future of personal finance, eh?
A. It’s pretty fascinating… sites like Prosper.com and LendingClub.com are changing the game. The concept has been around for many years, but has recently passed the credibility threshold: use technology to facilitate transactions between people with money to lend on one side, and individuals who need to borrow on the other.
Q. So who’s really doing this now?
A. Countless consumers with reasonable credit scores are stuck with extremely high rates on credit card debt, and would be thrilled to take out a consolidation loan at a lower rate. Countless investors are desperate for yield and can stomach a little risk. Peer to peer lending brings them together.
Q. So the sites are really providing the middleman function of a bank…
A. Right. Lenders fill out a very simple loan request and provide their credit scores and employment status, along with a short explanation of why they’re good candidates for a loan. The sites verify the data and segment the lenders into different risk categories who pay accordingly different rates.
Q. But, for lenders, aren’t these pretty high risk loans?
A. Usually, no one lender fills a given loan request; investor dollars are spread across many borrowers (radically reducing risk), and borrowers effectively borrow from a given consortium of lenders. Naturally, some defaults are fully expected, and are factored in to anticipated returns to investors. So far payment experience has been more or less in line with charge off expectations, given the borrowers’ histories and credit ratings.
Q. And what kind of interest rates do lenders earn?
A. Depends on the credit quality of the pool of lenders they choose to lend to… you can sort of go low-medium-high. So somewhere from the middle single digits right up to the low double digits, depending on your risk appetite.