Explaining U.S. Peer-to-Peer Lending (Part 1)


Ever since Lending Club’s wildly successful IPO in December of 2014, peer-to-peer lending has been thrust into the forefront of the financial world in regards to alternative lending options.

Even though more and more people are becoming aware of this disruptive alternative lending option and financial experts often recommend p2p loans as a debt consolidation option, many still remain in the dark.

So we will get a clear view of what peer-to-peer lending is in this series of articles. Let’s get started, shall we?

Firstly, I don’t want you to be confused by the different names it may go by. Peer-to-peer lending goes by several titles.

Its been called person-to-person lending, p2p lending and social lending.

It can clearly be described in this manner: money being lent by people without a financial middleman to other people in need of loans. The established classification from Wikipedia is “the practice of lending money to unrelated individuals, or ‘peers’, without going through a traditional financial intermediary such as a bank or other traditional financial institution.”

Fundamentally, it involves people who have cash (investors) lending directly to people that need cash (borrowers). Clearly this is something that’s occurred between people ever since money existed.

But now,with the explosive development of internet websites aimed at filling consumer needs, this lending theory has been introduced and implemented on the web now.

Because of these technological advancements, borrowers can get loans from people they’ve never met before and retail investors are able to lend to anonymous borrowers according to their credit info. The individual lenders choose what level of risk to assume according to each borrowers creditworthiness and other factors, even the story behind why the loan is needed can come into play.

You’ll find a multitude of lending platforms around the globe that are making peer-to-peer lending available. In America there are two widely-recognized p2p lending firms: Prosper and Lending Club.

In addition, there are several businesses that do what is seen as “direct peer to peer lending”. These companies are different in the sense that they mainly formalize financing agreements between two parties that personally know each other like family and friends.

Businesses in the US doing this now are LendingKarma, Nationwide Family Mortgage, ZimpleMoney and several more. They handle the funding procedure for you and assist with setting up the contracts between the two parties.

While these firms supply an invaluable service, the emphasis of this article will focus on the mass-market peer-to-peer lending platforms like Prosper, OnDeck & Lending Club.

In addition, I need to high a differentiation between peer-to-peer lending and micro-finance. Microfinance generally handles quite small loans measurements (under $1,000) and are often run by nonprofit companies. I’m a huge supporter of micro-finance companies like Kiva, however, they serve another function and also have different goals from peer-to-peer lending platforms like Lending Club and Prosper.


A Brief History of P2P Lending Online

It was not until well after the new millennium started that for-profit p2p lending started to arise on the web. In 2005, Zopa started up in the UK as the world’s first online p2p lending service, and they are still going strong nowadays as the #1 p2p lending firm in the U.K. marketplace. In the United States of America, Prosper Marketplace started operations in Feb 2006 and within 9 weeks they’d received 100,000 members and serviced $20 million in loans.

They had the P2P loans marketplace to themselves until Lending Club started up in 2007. Within a year’s time of Prosper launching, Lending Club sprang up to contend straight against Prosper head-to-head.


A Short “Down Period”

Both Lending Club and Prosper “down periods” in 2008 and 2009. Meaning that both lending platforms were in operation but the did not allow new money to come in by way of investors. They had to do this because the Securities and Exchange Commission (SEC) required they the they register all loans through their platforms as promissory notes with the U.S. government. Prosper went through this process for nearly 9 months from October 2008 to July of 2009, Lending Club spent a little less time in this “down period” between April to October 2008. Fortunately, that is a thing of the past, all notes are registered tith the SEC and all financial results for Prosper and Lending Club are available to the public. The notes for both lending platforms are being offered by a prospectus filed with the SEC.


Peer-to-Peer Lending Matures & Improves

After moving on from their down periods, both Prosper and Lending Club became more dedicated to risk-management. The first loans created in the early days (2006 and 2007)on Prosper’s platform did not perform well for early investors. Many of their investors lost money, due to the borrower default rates that were too high to make stable investments. According to Prosper’s data, just under 40% of loans released in 2006 and 2007 defaulted. It was bad in the early going. With Lending Club the numbers still aren’t great, although somewhat better. From the loans handed out before their “down period”, around 24% of those defaulted.

Today, in the event that you take a look at loans served after their period in the initial year, the yields for investors as well as the default rates are much better. At the time of this writing (many of the loans continue to be outstanding), the default rate for Prosper loans given from July 2010 through June 2011 is just more than 5.5%. For Lending Club, through the exact same time span, their rate of loan defaults is about 4%. It’s clear to see that both lending platforms have refined the process and found a formula for success, investors are enjoying consistent returns and borrowers are getting great rates.

Recently, both lending firms have made the appeal of peer-to-peer lending even greater by listening to consumers and introducing more products to the alternate lending market. Both US p2p lending platforms now offer small business loans, something that borrowers clamored for. In regard to personal loans, it is now possible to invest with more flexibility, both companies offer three and five-year loans.


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