The online-auction culture strikes again. Prosper.com, a person-to-person lending organization, is aiming to be the eBay of personal loans.
Say Mark wants to get a better return on his money than the 5.2% he'd earn on a three-year CD and wouldn't mind the satisfaction that comes with helping someone out. Enter Jenny, a single mother of three, who wants to start a home-catering business to supplement her income. She posts her request for a $4,000 loan on Prosper.com. Mark sees that Jenny has been assigned an AA grade based on her excellent credit and that she is asking for a maximum interest rate of 8.5%. He creates a Prosper account, transfers money into it from his bank and bids $500 at 8%. When her loan is fully funded, Jenny can either take the money or wait until the end of the auction to see whether she gets more-attractive offers. Mark is notified if he has been outbid and has a chance to make another offer. The lenders with the lowest bids to fund Jenny's loan win.
The process for reimbursing you, the lender, is simple. Every month a payment plus interest is deposited into your Prosper account. For servicing your loan, Prosper charges an annual fee of 0.5% of the total amount you lend.
Loans are reported to Experian, the credit bureau that also verifies borrowers' identities and assesses their creditworthiness. Still, you're taking some risk. The current default rate is less than 1%, but more-accurate results won't be available until loans start coming due at the end of three years (the term of all Prosper loans).
One way to safeguard your investment is to lend to an individual who belongs to an affinity group, such as schoolteachers in Iowa. Borrowers who belong to a group qualify for better interest rates because they are subject to peer pressure to pay back their loans.
Despite the risks, credit experts think that person-to-person, or P2P, lending could be a good investment. "It's a way to diversify your portfolio into an area with little correlation to other financial instruments," says Greg McBride, of Bankrate.com. He recommends spreading your money over several loans with different levels of credit risk. "The key is to think like an investor," he says.