Peer to Peer Lending

This discussion is focusing on alternative investments. I’d like to introduce a different area that I have been pursuing, peer to peer lending (known as P2P). This is a relatively new investment vehicle made possible by the internet. Just as Ebay made it possible for individuals to sell small items to others easily via the internet, P2P lending makes it easy for individuals to loan small amounts of money to others via the internet.

Investors open accounts with P2P providers and deposit funds with them. Borrowers use the same provider and request loans. The provider’s web site provides a mechanism to match the two, and execute the loan. Following is a brief description of how it works,

A borrower fills out a loan application at the web site and provides some required personal information. They use this approach because it’s easier and less expensive than trying to get a bank loan. Typically, borrowers are seeking money to consolidate debt or to pay off credit cards. A borrower might seek $10,000 to pay off credit card debt and agree to pay back the loan over 36 months at a lower rate.

The provider collects the information, runs credit reports and background checks, and rates the credit worthiness of the borrower. They assign an interest rate and create a “Note” describing the proposed loan. The provider then lists these on the provider’s web site.

Investors can review the available “Notes”. They have access to information about the borrower, purpose for loan, amount desired, length of the loan, and the interest rate. They can then offer to make part of the loan, generally something like $25.

When investors have agreed to cover the total loan, the provider issues the loan. They transfer money from the investor’s accounts to the borrower’s account. In the $10,000 example this might involve 400 investors each loaning $25 to the single borrower. The borrower makes a single monthly payment to the provider. The provider divides the payment and credits each investor’s account with their portion.

The provider charges small fees to both the investors and borrowers for their services. They will also pursue collection of late and bad debts. The provider wins because of the fees they earn. The borrower wins because they pay lower interest rates. The investor wins because they earn higher returns on their money. Banks and credit card companies are the losers because they lose very profitable business.

We have opened regular investment accounts at the two biggest providers, Lending Club and Prosper. I will be reporting on our experiences over the next several weeks. In the meantime, you might do an internet search on peer to peer lending.