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Peer to Peer Online Lending: Good, Bad or Ugly?  |
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 On the surface, it sounds like the best idea ever. On the one hand, you have people who are struggling with debt who can’t qualify for lower rates from conventional lenders or credit card companies. On the other hand you have a group of people with money to invest who are looking to get a better return than they would normally get with traditional investment opportunities.
No it’s not a new dating website; it’s the newest trend in Internet-driven finance. It’s called peer-to-peer lending, and it connects people with money to lend to people who need to borrow money. Sites like Prosper.com, allow the perspective borrower to supply all the details of why they need the loan and what they are willing to pay for it. Then perspective lenders can review their information and creditworthiness and “bid” on the borrower’s business.
But the question is, is this a good idea? It could be the best idea ever, but at the same time, it is far removed from conventional lending, which demands that both borrowers and lenders consider some things before getting involved. If you’re thinking about peer-to-peer lending, consider the following:
There’s no guarantee that a lender will be repaid: If any site promises 100 percent, on-time repayment to prospective lenders, walk away. They simply can’t promise guaranteed payments or returns. Conventional banks can’t guarantee full repayment of the money they lend, so how could an online site do it? If you decide to participate as a lender, your first objective is to consider risk. Think about it – if you’ve bought stock in a company that goes out of business next week, the value of your investment may shrink to zero. Lending or investing money entails risk – you have to understand how much you can safely take on.
There’s no way to guarantee that a borrower or a lender may be who they say they are: While verification policies and procedures vary at different lending sites, Prosper.com promises users it will work with law enforcement to track down borrowers who acquire loans through fake identities and promise to make lenders whole for the amount they’ve had stolen due to proven identity theft. Keep in mind that doesn’t provide a guarantee for anyone who skips payments on a loan, and recent reports show that many peer-to-peer loans have significant late payment or default rates.
You need to be confident your own information is protected: Keep in mind that you’re surrendering your name, address, credit and Social Security information to this third party to verify your identity and creditworthiness. Even if they’ve been in business awhile, make sure you understand what protections are in place to make sure your critical financial data is protected.
You need to understand how late payments are handled: The peer-to-peer lending site keeps the payment records, and it should report any late payments or other irregularities to the three credit reporting agencies. At the same time, make sure there are no prepayment penalties – any borrower should be free to prepay their loan ahead of time.
Watch issues that could affect your credit score: Reputable peer-to-peer lending sites will only report credit activity on loans that have been originated, not when a prospective borrower creates a listing. That means if you apply for a loan and there are no takers, that shouldn’t impact your credit rating.
Watch how the site mitigates lender risk and borrower advantage: At Prosper.com, you’ll notice that each proposal has a little measurement bar that indicates what percent of the loan has committed bids. That bar indicates the number of potential lenders who have stepped up and agreed to fund a portion of the loan at a rate somewhere under the maximum the borrower is willing to pay. That’s important. First of all, that indicates that there will not be one lender, but several, meaning that a single lender wouldn’t be on the hook for the whole amount. The borrower gets the advantage of multiple bidders willing to lower their interest demand in exchange for the business.
Information for this article has been provided by the Financial Planning Association
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