Lending with the Human Touch

When you need $500, you probably don't run next door and ask your neighbor for it, the way you would borrow an egg. But millions of borrowers are turning to their virtual neighbors for financial assistance through person-to-person lending agreements.

Person-to-person ("P2P"), or social lending, may not be the way to finance a home or a car. But it's becoming a popular vehicle for those in dire straits to pay for their groceries or to ward off a collection agency, chasing down an overdue electric bill.



Social lending isn't new by any stretch -- friends and families have made loans to one another for thousands of years -- but modern technology makes the process efficient and formal, structuring loans in a legal, professional manner that results in fewer defaults (not to mention spoiled family gatherings).

Social lending has been taking off because traditional bank loans and credit limits have tightened, says Curtis Arnold, co-author of The Complete Idiot's Guide to Person-to-Person Lending. "Consumers are looking to other credit sources, propelling P2P lending as a viable source of credit."   And it's appealing for both borrowers and lenders, not only because it cuts banks out of the picture, but also because users give the transactions an air of humanity, posting pictures and anecdotes on social-lending websites. Borrowers can turn to associates for help -- hitting up alumni groups, for example -- and lenders learn who they're helping. Best of all, lenders have a prospect of a good return -- Lending Club advertises a return of more than 9%.

But there are risks too. "Just like in any investment," Arnold says, "there's also a chance you won't make money -- or might even lose money." Borrowers have to be cautious, too: "In many cases," he says, "borrowers save a lot of money on interest with P2P loans, but they have to check the rates versus bank loans." If a borrower has a questionable credit history or low score, getting a social loan funded could be tough.

"A savvy lender will do their homework on the borrower's history," Arnold says. "If a loan looks risky, they might pass on it." But borrowers with good credit usually end up with better interest rates than they might get through a bank loan.

When you're exploring your social-lending and -borrowing options, don't assume that all sites are equal. Every site has a different platform, a different distribution system, and different credit-score requirements both for lenders and for borrowers. Arnold's suggestion: read the FAQ, and follow it with a note to the administrator asking how the site works, what the default rates are, and so forth. Above all, he says, keep your specific needs in mind.

Among the most popular social-lending sites are:

• Loanio. An auction-based P2P service allowing lenders to view credit-summary data and other information that the borrower provides. Lenders place bids on all or part of a loan by posting how much they're willing to bid, and what rates they're offering.

• LendingKarma. This site focuses on the loan agreement, setting a first step of defining the terms in writing. A loan-payment tracker lets lenders and borrowers track payments, allowing creditors to keep their borrowers on track with payment reminders.

• Lending Club. Lending Club's tough requirements -- it screens potential borrowers' credit scores before signing off -- may reduce some of the risk associated with the practice. The site has just ended a quiet period and is not yet available in all states.

• Virgin Money. With more than $300 million in loan volume since 2001, Virgin is leading the charge in managing loans among relatives and friends. A pioneer in the emerging social-lending space, Virgin also offers options for student loans.

• Prosper. Once the largest P2P lender, Prosper is changing its trading platform to a format similar to that of Lending Club, launching to lenders in California and borrowers nationwide.