In between Chase Manhattan Bank and Vinny, who will break your legs if you don't repay your loan, lie new and novel online lenders that act more like dating services than banks.
They match people wanting money with others who have money to lend.
The two biggest such 'peer-to-peer' lenders, LendingClub.com and Prosper.com, offer borrowers lower rates than banks, and offer investors a better return than they could get from putting their money in a CD. Both companies are headquartered in the San Francisco Bay area, and both are licensed in most states. Rates and rules for the two are similar.
Chris Larsen, CEO and co-founder of Prosper, calls peer-to-peer lending a throwback to the way small loans used to be made to ordinary people, before credit cards came into wide use. "We've brought back the simple, basic installment loan—the kind you can use for home improvement, debt consolidation, buying a car or paying for school. These are unsecured loans of anywhere from a few thousand dollars up to $25,000, at low fixed rates. The terms aren't tricky. There are no repayment penalties, no 'gotcha' fees."
True, he says, his lenders are, "looking for a nice return." But many bring an attitude to their lending that's different from what one finds at banks: "They're interested in helping other Americans, in impacting other people's lives directly."
While investors' money does not enjoy the FDIC protection it would have at a bank, it enjoys a better than 10% return. Plus, lenders can diversify their risk by dividing their investment, if they want, across hundreds of different loan accounts in increments as small as $25.
At LendingClub, a borrower with a good credit rating can expect to pay an interest rate five percentage points lower than at a bank. CEO and co-founder Renaud Laplanche says what he and Larsen have done is eliminate the middle-man. "By creating a platform where investors can make loans directly to prime consumers, we eliminate the intermediary. Most people don't think of banks as middlemen, but that's exactly what they are: They collect money in CDs and savings and give you a half percent, then turn around and lend it out at 16% or 18% as unsecured credit. The spread goes not so much for profit as to pay for branches and other infrastructure costs." Having no such infrastructure costs, Laplanche can afford to offer borrowers and lenders better terms.
LendingClub, with an 80% share of the peer-to-peer market, is growing at a rate of 10% a month. "We issued $13.5 million in loans in December," says Laplanche, "up from $12 million in November. If you compound our growth rate, we'll be the size of Citibank in three years."
Since its start in 2007, LendingClub has funded nearly $204 million worth of loans and has paid over $15.6 million to its investors.
Borrower John Good, 29, turned to LendingClub out of frustration. Good, owner of Bubbles Galore, a car wash in Davison, Mich., wanted to expand his business by adding a dog washing service. "My wife and I love car washing, but diversification is key."
But when he told his bank about his plan, they told him he was all wet. "They stuck up their noses up at the idea," he said. "Nothing is worse for a business owner who's attempting to bring an idea to fruition than to be told it's terrible and won't work."
All Good wanted was $16,000. "My attitude was, 'Guys, just give me the loan for Pete's sake!'" He looked elsewhere and found LendingClub.
"Once we applied for the loan, it was all very easy," Good said. He posted a listing on the website explaining how much money he needed and what he intended to do with it. In a few days his loan was fully funded by 174 small lenders. Two months after that, he was washing dogs.
How's it going?
"Just fantastic," Good said. "We opened in time for Mother's Day, 2010, and right away were washing 10 to 12 dogs a day. People drove from 45 miles away. And they didn't just wash their dogs, they got their cars washed, too, and they used our detailing service."
His experience with LendingClub, he said, "was good for me and good for the lenders."
Indra Singhal of San Jose, Calif., likewise had a positive experience — as a lender. A self-described serial-entrepreneur and "typical Silicon Valley guy," Singhal, 53, was looking for a good fixed-income investment. "But when I looked around, the returns were just pathetic."
Then in 2009 he found LendingClub. At first, he made mistakes, investing in some loans that went bad. "You get a default, and you freak out. Then, after a while, you realize that defaults happen—it's just the nature of the business."
He devised his own methods for distinguishing borrowers who would be good risks from others who would be bad. "A fair amount of defaults come among folks borrowing the maximum amount, $25,000, so I shy away from those. People borrowing for small businesses have more defaults than people paying off their credit cards. Vacations and weddings are really good purposes to lend to. They may be late to pay, but few default."
In all, he's lent $80,000 to 1,015 borrowers and has gotten a 14% return. What else has he gotten? Entertainment. "Reading loan requests, you learn to read between the lines."