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You know that
house down the street that’s for sale? The gigantic castle of a house,
with an uncut lawn, a few weeks away from foreclosure? That’s your
fault. After all, it was you who loaned the former owners the money for the
house they could never afford.
No way, you say?
You’d never have loaned any money to that irresponsible hack. But of
course you did lend it to him… just not directly. That’s what
banks are for -- lending your money to other people, often people just like
the owner of that house.
Forgetting for
the moment how modern finance found a way to twist and pervert the banking
system to its breaking point, for hundreds of years the foundation has been
one of shared benefit and distributed risk. You keep some portion of your
savings in a bank, and in exchange they share back a percentage of the
proceeds from lending your money to others (including Mr. Irresponsible),
keeping a cut for themselves.
That’s been
the only option. Until now…
If the Internet
is good at one thing, it is connecting large numbers of people to each other.
Thus it seems only logical that the Web would be a more efficient way of
matching lenders to buyers than any one local or even national bank.
Electronic systems can connect people at scale, automating an otherwise
manual process and eliminating scores of middlemen from the process. And that
is exactly what a handful of new lending institutions on the Web -- such as www.prosper.com and www.lendingclub.com -- are starting to do.
They call it
“peer-to-peer (or P2P) lending,” and the premise is simple: I
have money I am willing to lend; you would like to borrow some; these
companies bring us together and facilitate the loan. Because their systems
are automated and connect lenders and borrowers more directly, the companies
can afford to take much smaller commissions on the loan than a traditional
bank.
As a result, you
enjoy a much higher yield than on your savings account, and they attract
borrowers by undercutting bank rates. Prosper’s returns for lenders
average 7.02% for the highest three credit grades (the only data they make
available). Lending Club averages 9.62% across all loans for investors. And
credit is available to borrowers as low as 7.89%, much cheaper than most
banks.
An investor can
diversify by bidding to fund portions of many loans, in increments as low as
$25 each. A $5,000 loan might be spread across as many as 200 individual
lenders, each choosing to purchase a $25 note. The process is largely
invisible to the borrowers, as they receive just one payment and pay just one
bill. The companies collect and distribute the payments to each lender,
proportionally to the amount each funded.
One of the more
interesting, and unconventional, aspects of the sites is the way they use
social networking tools to provide lenders and borrowers with a way to
connect more directly. On each site, borrowers are required to provide not
only credit history and similar information, but a brief personal statement
on why they want the loan, and anything else they think is relevant. Lenders
can browse the loans and pick specific people and specific requests they want
to fund. Prosper.com takes this farther than LendingClub.com, allowing
borrowers to add photos and encouraging more dialogue -- on Lending Club, the
descriptions are often just simple half-liners like “Buying a used
Acura RSX.”
Browsing the loan
requests provides a fascinating peek into what people borrow money for
(weddings, used cars, debt consolidation, and home repairs look to be the
most common, in no specific order), not to mention their credit histories,
borrowing habits, and even spelling and grammar…
This technique of
hand picking loans only scales so far, especially when lending $25 at a time.
So both lenders also offer automated matching of loans to your criteria (loan
amount, credit score, etc.). Prosper.com’s system is more automated and
much simpler to use, but both are adequate for the job.
Of course, you
also lose the liquidity that comes with indirect vehicles like bank accounts.
But both lenders try to address this issue by packaging your loans as notes
and allowing you to trade the notes in a market provided by FOLIOfn. Prosper.com has only recently restarted lending
after a government-mandated quiet period while their note model was reviewed
by the SEC, so activity on their trading platform is limited as they build
the network. However, the Lending Club version is working smoothly, providing
decent near-term liquidity options (and some good opportunities for
arbitrage, we imagine).
If you’re looking for a way to diversify
some of your investment activity beyond traditional stocks, bonds, futures,
and the like, P2P loans could make for an interesting choice. Or if you just
want to try the next new thing, they make for an entertaining way to play
banker for a day (or 36 months, the length of the loan terms on both sites).
Technology is the number one growth industry in
the U.S. – and many of those investors who have kept their eyes open
for new, promising tech developments have been making fortunes in the
process. Just think of the lucky people who invested in Google when it was
still a small startup.
Finding the next Google is not impossible, but
you have to know what to look for. Read this new report to get some
ideas… click here.
By : Alex Daley
Senior Editor, Casey’s
Extraordinary Technology
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