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What is Peer to Peer Lending?

Peer to peer lending (P2P Lending) simply refers to the process of individuals loaning each other money directly rather than through a third party institution such as a bank. In the context of the internet, peer to peer lending generally refers to the business of individuals lending each other money through a loan origination marketplace such as Prosper.com or Lending Club.

Let’s say that you want to borrow money from Prosper, Lending Club or another P2P Lending website. First, you would create an account on the loan club’s website. The company would then pull your credit score and assign you a letter grade for your credit. After your credit is checked, you can post a loan on the loan club and then there’s a period where lenders can choose to partially fund your loan. Typically, your loan will be filled by many different investors that all put $25 to $100 toward your loan.

After your loan is fully funded, you will receive the funds via check or electronic transfer. Typically loan periods are anywhere from 3 to 5 years. You’ll make the payment to the loan club and they will distribute your money to the investors that helped fill your loan.

Peer to Peer Lending Companies:

Lending Club is currently the largest peer to peer lending company in the United States. Its borrowers pay fixed interest rates based on their credit score. Lenders can review listings from borrowers and partially fund loans that they believe will perform well. Since the company began in 2007, its lenders have averaged a 9.64% rate of return on their money. Lending Club has been praised by its investors for screening its borrowers and using much better collections practices than its primary competitor, Prosper.com. Read our full write-up on Lending Club.

Prosper.com was the first company in the P2P lending industry to generate a significant number of loans in the United States. Since its inception, it has had some legal issues with SEC but has since gotten them settled. On Prosper, customers wishing to get a loan make a request to borrow a certain amount of money and set a maximum interest rate that they are willing to pay. Lenders on this p2p lending website bid on individual loans and commit to funding a portion of the principal balance and set the minimum interest rate that they are willing to take on a particular loan. Prosper.com manages the process, known as a reverse Dutch auction, and assembles the best bids to provide the borrower with the lowest interest rates that lenders are willing to pay on the loan. Read our full-writeup on Prosper.com.

Legality of peer to peer Lending

In the United States, the two major peer to peer lending companies, Prosper.com and Lending Club, both faced issues with the Securities and Exchange Commission for selling unregistered securities. As of mid 2009, both p2p lending companies have made arrangements with the SEC and are operating legally within the United States.

peer to peer lending companies also have to meet state lending regulations. For this reason, both Lending Club and Prosper.com do not currently operate in all 50 states, but both companies are working on meeting the requirements of additional states in the near future.

Getting a Personal Loan from Lending Club or Prosper

If you are looking to get an unsecured personal loan to purchase a major item such as a new vehicle or furniture, to take a vacation, to make renovations, to refinance existing debt, to fund your college education or to gain capital for your business, getting a loan from individuals through a peer to peer lending firm such as Prosper.com or Lending Club may be an excellent way to get a loan.

The interest rate that you will receive will vary based upon your credit standing. Currently Lending Club is offering interest rates between 7.05% for its most credit worthy borrowers and 21.21% for the highest-risk borrowers. The rate that you will receive from Lending Club or Prosper is likely going to be much more competitive than you would receive from a credit card or on an unsecured loan at a traditional bank.

With both companies, your loan will be amortized over a 3 year term. Both p2p lending companies have a maximum limit of $25,000 for the size of a loan. There will also be an origination fee of 0.75% to 3.0% depending on a number of factors.

Investing with Prosper or Lending Club:

Becoming an investor with Lending Club or Prosper.com is a relatively simple process. It’s a much different investment than stocks, bonds or real estate and is really its own asset class. Currently, it’s considered an alternative investment and you shouldn’t put a substantial percentage of your nest-egg in peer to peer loans, but some investors have earned interest rates between 9% and 12% on their money.

There are also some investors that put money into Prosper.com early on and have seen high default rates. Both Lending Club and Prosper.com have made efforts to be more selective about who can qualify for a loan to reduce default rates and improve rates of return. Checkout the links under “Related Links” to find some tips for Lending on Prosper.com and Lending Club

Related Links:

Here are som additional articles that American Bankning News.com has published in the last several months regarding Prosper.com, Lending Club and the p2p lending industry.

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