Since 2009, bankers have stopped paying any meaningful interest on deposits, Consumer Reports notes. And when they do lend, it can be at rates in excess of 10 percent, even to borrowers with excellent credit.
Fortunately for consumers, new intermediaries – peer-to-peer lending platforms – are bridging the gap, enabling ordinary people to lend or borrow.
Think of them as eBays for money: Just as eBay brings buyers and sellers together, peer-to-peer platforms bring borrowers in need of loans from $1,000 to $35,000 together with investors who want to earn better returns than those offered by banks.
The peer-to-peer platforms grade borrowers based on their credit scores, which are then used to set the interest rates they will pay for the loans they receive. Investors usually don’t lend to a particular borrower. Instead, their investments, which can be as low as $25, are pooled together with loans from others.
Once a loan is funded, the peer-to-peer lender issues it to the borrower but takes an origination fee. The amount depends on the grade of the loan. As the borrower repays principal and interest, the investors receive their share of the repayments.
The two largest peer-to-peer platforms, Lending Club and Prosper, have grown from online curiosities in 2007 to a duopoly that has facilitated more than $8 billion in loans, most of it in 2014 alone.
Should you consider peer-to-peer lending, either as a borrower or an investor? For some, it may have advantages. The marketplace often functions in a faster, more efficient manner than loan officers at a bank branch. Even so, the risks are similar.
Peer-to-peer marketplaces are relatively new. They’re regulated by the Securities and Exchange Commission and are required to register in individual states as well. Lending activities must comply with federal and state consumer lending laws.
Here’s what Consumer Reports suggests keeping in mind before turning to a peer-to-peer platform:
If you’re looking for a loan
• Check your credit score. Your FICO credit score will give you a general idea of what grade you’ll receive from Lending Club and Prosper, which in turn will inform the interest rate on your loan.
• Know that there will be fees. Prosper calls them closing fees and Lending Club calls them origination fees, but in both cases, the platform charges you for completing a loan. Fees range from 0.5 percent to 5 percent of the value of the loan, which is comparable to the fees that banks charge for credit card balance transfers, and they’re deducted from the amount of the loan.
• Apply at both. You may find different rates at the two platforms, so make comparisons to determine the better offer.
• Don’t ask for more money than you need. You can borrow $1,000 to $35,000, but the more you borrow, the more you’ll pay in interest.
If you want to invest
• Steel yourself for some level of risk. Remember, you’re making an unsecured loan to unknown borrowers, Consumer Reports says.
According to Lend Academy, a website that focuses on the peer-to-peer lending industry, 1 percent to 10 percent of three-year loans issued from 2009 through 2012 across all credit risks weren’t paid back. That means that investing in higher-yielding, higher-risk loans could put a dent in your returns.
• Diversify. Both Lending Club and Prosper encourage you to diversify your investments. By lending, say, $50 to 40 borrowers with the same rating, instead of $2,000 to one, you reduce the risk that comes with a borrower who defaults on a loan.
• Use the community. An online network has grown alongside peer-to-peer lending platforms, creating databases and other resources to share wisdom about investing in such loans.
• Remember that your competition is Wall Street. Hedge funds have been taking increasingly bigger bites out of the peer-to-peer marketplace, essentially employing their algorithms to cherry-pick the juiciest loans.