In the wake of the subprime mortgage meltdown, traditional financial institutions have tightened up on who gets to borrow money. But some people are still finding ways to borrow the money they need, thanks to another area of lending that is booming.
Person-to-person lending, or “social” lending, is growing at a phenomenal pace on the Internet as consumers look for an alternate way to pay off debt, according to new research by Javelin Strategy & Research. Javelin predicts that the demand for person-to-person lending services, or P2P, to pay off credit-card debt may grow from $38 billion to $159 billion over the next five years.
But while many people see opportunities to get cash that might not otherwise be available to them — and lenders see a way to deploy some of their extra cash — participants in this emerging form of lending should heed several caveats.
One company seeking to fill the gaps in the private arena is Prosper, an online loan auction site.
People who need a loan create a listing for up to $25,000 and set the maximum rate they are willing to pay. Lenders set the minimum interest rate they are willing to earn and bid in increments of $50 to $25,000 on listed loans.
Once the auction ends, Prosper takes the bids with the lowest rates and combines them into one loan to the borrower. The company handles all the administration of the loans, including the repayments and, in the case of a default, collection actions.
Prosper charges a 1 percent to 3 percent loan closing fee. The company also earns money servicing the loans for lenders.
In Javelin’s survey, 36 percent of borrowers said they used the service for the better interest rate. Some (33 percent) have turned to P2P to avoid using credit cards. Others (27 percent) go that route because they do not qualify for a loan from a bank or credit union.
Clearly, borrowers benefit. They can formalize lending agreements and often get a rate better than at a financial institution or pay off higher interest credit card debt. For lenders, they, too, get a better rate than they might get depositing money in a high-yield checking or savings account.
But I see a lot of downsides, too.
People may be lured by the promise of better rates earned on their money without carefully considering the higher risks. The default rate is higher compared with what financial institutions experience.
Lending to a family member or friend can be fraught with problems. There’s also the issue that people are more often turning to P2P lending to pay off other debts. It’s far better to cut expenses or increase your income, or both, than to try to borrow more money, even at a lower interest rate.
Michelle Singletary: singletary@washpost.com
