If you haven’t heard about peer-to-peer lending sites like Prosper and Lending Club, the sites where people can lend money directly to others who need loans, I’ll be writing today, tomorrow, and Friday about this cool new alternative to traditional lending.
Today I just want to provide an overview of peer-to-peer lending for those unfamiliar. Tomorrow I will post an update on my borrowing experience at Prosper, and Friday I will have a fun little article highlighting six possible uses for Prosper loan.
What is Prosper?
Prosper is a peer-to-peer lending business, meaning you could loan money to me and vice versa. As the borrower, I pay interest on my loan which is then paid to you, the lender. Prosper is free for lenders, and borrowers pay a small fee based on the amount of their loan. In my opinion, this model is the way of the future, as it cuts out banks whose interest rates short-change savers and rape borrowers. On Prosper, rates can be lower for borrowers but higher for investors because there is no profit-thirsty bank in between them.
How Prosper Works
First, there needs to be money. Lenders open a Prosper account with as little as $25 have money transferred from their bank account to a Prosper account.
Second, potential Prosper borrowers create profiles on the site including biographical information, a photo, the amount they are requesting, their preferred interest rate, and the reason they’re requesting a loan, and also financial information including their creditworthiness and debt-to-income ratio.
Lenders then browse the potential borrower profiles and select several that they want to lend to. Usually, lenders diversify their investment across many borrowers to reduce risk, and borrowers’ loans are funded by dozens or hundreds of different lenders.
Borrower’s profiles remain active for a set amount of time (seven days, for example). If lenders commit enough money to fund the loan, then lenders begin to bid on the interest rate, driving it down for the borrower.
For example, if Joe asked for a $1,000 loan at 15% and ten lenders agreed to loan Joe $100 each in the first five days, Joe’s loan would then be open to bidding. If new lenders came along and decided they would like to loan Joe money at 14%, his interest rate would start to go down. The initial lenders would then have to re-bid at a lower interest rate to be able to loan Joe money.
Borrowers can also select “automatic funding”, meaning the loan is issued as soon as enough lenders are reached, and there is no bidding on the interest rate.
Once a loan listing ends and is funded, money is transferred out of the lenders’ accounts and Prosper issues the money to the borrower. The borrower makes automatic monthly payments to Prosper for three years, and Prosper redistributes the money, plus interest, to the lenders, who can then reinvest the funds in new loans.
Should a Prosper borrower default, collections methods are used to attempt to recover the lenders’ money. It is possible, however, for lenders to lose their investment due to defaults.
Another feature of Prosper are its groups. Prosper groups are ways of people with either a real-world or virtual connection to lend money to each other. The idea behind groups is that people who have a connection (for example alumni of a particular school or members of a church or club), will be more likely to lend to each other and less likely to default.
While it is not necessary to join a group to borrow or lend on Prosper, the site advertises that joining a group can result in more easily funded loans and lower interest rates for borrowers. Lenders can also elect to become “group leaders” and earn a small commission when borrowers in the group successfully pay off their loans. You’ll be able to browse the profiles, read about members’ experiences on the forums, and set up a funded account if you want to lend money or request a loan if you need to borrow.