It took Karla Brazelton just three days to round up nearly 100 strangers willing to help her reduce her $7,000 credit card debt. Brazelton, a 48-year-old senior accountant with the city of Detroit, wasn’t looking for handouts. In September 2009, she joined an online peer-to-peer loan network known as Lending Club, where, with small contributions from a random collection of members, she secured a 36-month personal loan at 7.74% interest. She used the money to pay off seven credit cards with interest rates that ranged from 14% to 22%. “I was surprised it happened so fast,” says Brazelton. “I assume the investors were attracted to my high, 780 credit score.”
Peer-to-peer lending networks are the Facebooks and MySpaces of money. But instead of collecting online “friends,” loan-seekers look for people who are willing to lend them money. What do the lenders get out of it? A better rate of return on their money than they might receive if they left it in a savings or checking account or another traditional financial vehicle. In the aftermath of the credit crunch and Great Recession, banks are still wary about extending loans to consumers and small businesses. Their caution has prompted a growing number of potential borrowers to search for loans online.
There are several types of lending networks. Some focus on student loans; others seek to fund entrepreneurs in developing countries. Loan amounts vary from several hundred dollars to several thousand. In the U.S., these networks are regulated by the Securities and Exchange Commission. The largest lenders offering p-to-p loans are Lending Club, Prosper Marketplace Inc., and Kiva. Other sites, such as GreenNote and People Capital, specialize in lending to students. In 2006, the dollar amount of p-to-p loans outstanding in the U.S. was $269 million. That figure grew to $647 million in 2007, and is expected to total nearly $5.8 billion this year, according to Celent, a Boston-based financial research and consulting firm.
How Peer Lending Works
At Lending Club, the largest U.S. peer lending network by volume, potential borrowers join (there’s no fee), and submit their basic information, including their Social Security number. All personal information is protected by online privacy settings. Lending Club uses the data to obtain the applicant’s credit report. Its underwriters then verify the applicant’s employment and income, and use the credit score, debt-to-income ratio, employment history, and other information to determine the applicant’s creditworthiness. The loan request is then assigned an interest rate between 6.78% and 24.95%. Once approved, the applicant can post a request on the site for potential funders. Borrowers write a brief narrative describing how they plan to use the money. They share details, for instance, about future home renovations, auto financing, or paying off a student loan. A majority of Lending Club borrowers (62%) use their loan to pay off higher interest debt.
In her post, Brazelton introduced herself and explained that she was seeking $7,000 to consolidate her credit card debt at a lower interest rate. As funders clicked on her post, they read her request and viewed her credit score. “If investors don’t see the information they want they can ask a specific question,” says Lending Club spokeswoman Katherine Madariaga. Brazelton says funders asked about her job history and salary. In the end, Brazelton’s interest rate of 7.74% on the $7,000 loan was considerably lower than the average bank loan rate of 14.8% at the time.
Investors who wish to help fund loans like Brazelton’s join Lending Club by putting up a minimum investment of $2,500 which they can spread across as many as 100 loans. The minimum they can contribute to a borrower’s cause is $25. For more than a year now, Brazelton has been making monthly payments of $218 to the Lending Club. As she pays back her loan, Lending Club incrementally repays Brazelton’s roughly 100 funders—with interest. The net annualized return for investors on Lending Club’s platform, according to the company, is 9.67%.
What to Know Before Applying for a P-to-P Loan
Despite its modern, high-tech nature, peer lending doesn’t necessarily provide an escape from the discrimination African Americans may face when applying for loans at traditional banks. Prosper.com, which operates somewhat differently from Lending Club, allows potential borrowers to include a photo of themselves in their posted loan request. Economists Devin Pope and Justin Sydnor reviewed 110,000 loan listings on Prosper.com in 2006 and 2007 and found that loan requests with photos of black applicants (or no photo at all), were about 30% less likely to be funded than similar credit profiles that included a picture of a white person.
The study also concluded that African American borrowers at Prosper.com paid interest rates that were 60 to 80 basis points higher than did similarly qualified whites. The results suggest that the pool of funders on peer lending networks exhibit the same racial biases borrowers might confront in a bank loan officer. Prosper.com was contacted for this article, but our calls were not returned. (Lending Club’s website doesn’t offer potential borrowers the option of including a photo in their posts; and Brazelton says none of her funders asked about her race.)
None of this information, of course, should dissuade people of color who are looking for a p-to-p loan.
Here are some strategies for getting your request funded:
- Pay attention to your credit score and other indicators of your financial health. The higher your score, the better your chance of getting your loan fully funded. The minimum credit score Lending Club allows is 660, and the debt-to-income ratio must be less than 25% (excluding mortgage). Prosper’s minimum credit score is 640. Keep your debt-to-income-ratio low, and maintain a solid history of employment and income. “We’ve seen the bar get higher and higher with the lending standards on p-to-p networks,” says Beverly Blair Harzog, co-author of The Complete Idiot’s Guide to Person-to-Person Lending (Alpha; $19.95). Even so, both networks require minimum FICO scores far below 700, which is now considered average.
- In your profile, be honest, upfront, and clear about the purpose of the loan. Transparency is key.
- Be persuasive. Convince potential lenders with as much detail about yourself as you’re comfortable with that you’re a good risk. “Tell them why you need the loan, how you got into this situation, and give them a peek into your character,” Harzog advises. “Remember, the people who invest in your loan are attracted to this not only because they want a return on their investment. They want to help people too.”
- If a potential lender asks questions, answer them as soon as you can—while you’re still on that person’s radar. Before you hit the Web in search of a p-to-p loan, heed one final cautionary note: New peer lending sites are cropping up all the time. Be careful trying out a new establishment. Do your research, which should include talking to people who’ve received loans through the sites you’re interested in.