NEWS AND RESOURCES

Financial Planning for July 2015

Peer Lending as an Alternative Funding Option

Sometimes people look for alternative lending sources because they have credit issues and can’t find a lender that will loan them money. When this happens, the sources they find might charge interest rates much higher than the current market rate. Other times, however, borrowers with perfectly good qualifications will look for an alternative lender for other reasons, such as better service or to avoid dealing with the bureaucracy of a traditional bank. These days, a new type of funding is available for just such a borrower. It’s called peer lending.

Peer lending is a part of a recent movement known as crowdfunding, but it’s a bit different. Crowdfunding is the process of raising small amounts of money from a large number of people. The Internet has made this type of lending possible by enabling borrowers to reach millions of potential investors that they do not know via an organized online platform. Some of the better-known platforms include Kickstarter, Indiegogo and Crowdrise. The borrower is often seeking funding for a project such as to film a movie or develop a new product.

Peer-to-peer lending, on the other hand, is the process of matching borrowers and lenders via an online platform. Peer lending has proven to be a viable way for the average consumer to get a loan at a competitive interest rate. This type of funding is also known as marketplace lending. Popular peer lenders include Prosper, Lending Club, Upstart and Looking Glass Investments.

Because it generally operates exclusively online, the overhead cost for the typical peer lender runs about two-thirds of that of a bank. This means it can afford to offer lower interest rates than many traditional lenders, so it attracts well-qualified borrowers. Although small in size, many peer lenders today have deep pockets. For example, Google now offers funding for small business loans to its partner vendors via Lending Club, one of the largest peer-to-peer lenders on the market. Other investors in these online lending facilitators include wealth managers, hedge fund directors, insurance and investment companies.

Peer lending has the potential to pose significant competition to traditional banks in the battle for qualified borrowers. Savvy entrepreneurs are increasingly seeking funding online in order to procure a lower rate than banks currently offer. Some peer lenders specialize in a target demographic, such as small business owners or young borrowers with limited credit history. For example, Upstart targets young college graduates looking to start their own business. It uses a proprietary predictive modeling algorithm that correlates education with future income and the likelihood of repaying a loan. Its interest rates currently range from 5 percent to 22 percent, depending on borrower qualifications. As a general rule, peer-to-peer lenders offer a range of interest rates from 6 percent for highly qualified borrowers to 30 percent or more for high-risk applicants.

To demonstrate how quickly a peer lender may respond to applicants, when a recent Dartmouth University senior applied for a loan at Upstart to pay relocation fees for an internship job, he received funding within five days.

To date, peer-to-peer lending is subject to little or no government regulation. The only guidance issued thus far came in 2010 from the Securities and Exchange Commission, when it required lenders to register with regulators and provide disclosures about how investor money was to be used. As for federal insurance, some of the larger lenders such as Prosper and Lending Club use a third-party bank to process loans, which protects them under the Truth in Lending Act and other federal consumer laws.

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