Peer-to-Peer Loans: What Borrowers Should Know

Last Updated Jun 11, 2010 3:22 PM EDT

I've been writing about peer-to-peer lending for quite some time and I admit I've always been a bit skeptical. The idea is to take the the financial institution out of the picture and create loan agreements directly with individuals. I think it can be a fine alternative for borrowers, but for lenders there are major risks involved: After all, who's to say this unsecured loan will ever be returned?

As it turns out the peer-to-peer lending industry is booming. Research firm Celent forecasts the overall "P2P" market will climb to $5.8 billion in loans this year, up 800% from 2009. On the one hand, traditional loans are hard - perhaps even impossible - to come by these days, which is making it all the more attractive for borrowers. And many lenders see this as an alternative investment strategy, with the (admittedly risky) potential for higher short-term rates of return than a traditional savings account or even the stock market.

Earlier this month Lending Club, an online peer-to-peer lending marketplace, announced that it facilitated more than $10 million worth of new loans during the month of May alone. According to the company, this is a record for any peer-to-peer lender in the U.S. Rival P2P site Prosper is originating roughly $2 million worth of new loans a month - a smaller, but still impressive amount.

If you're in the market for a loan - either for a home renovation, vacation or car - and facing rejection from traditional banks, P2P loans may be an alternative route to getting the financing you need. But before you make the leap, here are a few things to keep in mind.

Your Credit History Still Matters
To secure loans and to get the best interest rates, P2P lending sites want to make sure you have a solid credit score and history. The lower your ratings, the less likely you'll get allowed to participate. At Prosper, for example, you need a FICO score of at least 640 to qualify. At LendingClub it's 660.

Fees Apply
These sites need to make money, right? At Prosper, there are closing fees equal to a percentage of the amount borrowed - it could be anywhere from 0.5% to 3%, depending on your credit rating. At Lending Club, the web site states that borrowers "pay a one-time processing fee that ranges from 2.25% to 4.50% of the loan amount, depending on your loan grade, which is based on your credit quality."

There Are Limits
You can't exactly finance a new house with peer-to-peer lending, but you may be able to secure a partial loan. At both Prosper and Lending Club the borrowing limit is $25,000.

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    Farnoosh Torabi is a personal finance journalist and commentator. She is the author of the new book Psych Yourself Rich, Get the Mindset and Discipline You Need to Build Your Financial Life. Follow her at www.farnoosh.tv and on Twitter at @farnoosh.

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