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.
I certainly understand the appeal of utilizing the services of such companies. Often, especially in the current lending market, it’s hard — if not impossible — to get small unsecured loans.
I frequently joke that many people buy new cars not because they want one but because they can’t borrow the $1,500 or $2,000 they need to fix their current vehicle. It’s easier for people to borrow $20,000 for a car than $1,500 to fix one.
One company seeking to fill the gaps in the private arena is Prosper, an online loan auction site. Prosper works much like eBay, the online auction site, except instead of people listing consumer items, what’s being brokered are consumer and business loans. People who need a loan create a listing for up to $25,000 and set the maximum rate they are willing to pay a lender. People who register as a lender 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.
For its part in the person-to-person lending, Proper charges a 1 percent to 3 percent loan closing fee. The company also earns money servicing the loans for lenders.
Most recently, Richard Branson’s investment firm acquired a majority ownership stake in CircleLending. Branson is the founder and chairman of the Virgin Group. CircleLending has been rebranded Virgin Money USA (www.virginmoneyus.com).
Virgin’s business model differs from Prosper in that it helps manage loans only among family and friends. Starting at $99, the company will help put together a promissory note and payment schedule. For additional fees, the company will set up automatic payments, record a lien and service the loan.
The top three reasons consumers said they would use a person-to-person loan is to get a better interest rate. 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.
Higher-income and younger consumers are the most active users, but Javelin is predicting the appeal will widen as the social lending opportunities increase.
Clearly, borrowers benefit from this social lending trend.
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, as does Jean Garascia, an associate analyst with Javelin and author of its report.
“For lenders there is always the issue of default — will someone get paid back,” Garascia said.
People may be lured by the promise of better rates earned on their money without carefully considering the higher risks of this direct lending. Even with documentation, the default rate is higher compared to what financial institutions experience.
And when you add in a personal relationship, lending to a family member or friend can be fraught with problems. Will parents be willing to foreclose on the house where their daughter and grandchildren live?
There’s also the issue that people are more often turning to P2P lending to pay off other debts. In my experience, it’s far better to cut expenses or increase your income, or both, to pay back consumer debt than to try to borrow more money, even at a lower interest rate. Further, many people are borrowing for things they should be saving for, such as vacation.
Still, if you do consider formalizing a loan with a stranger, relative or friend by using one of these online services, please heed what Garascia said: “It’s important for both lenders and borrowers to be realistic about their finances and be honest about how much they are willing to lend, lose, borrow or afford.”
Washington Post Writers Group
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