Alternative lending sites often have good deals

— -- You list and bid for shoes, concert tickets and even cars online. Why not loans, too?

That's the thought that came to René Clayton last year when she heard about a website that connected consumers who wanted to borrow money with those willing to lend it. She was short on cash and wanted to buy a fence for her yard. But she didn't think she'd be able to take out a bank loan because of her already high debt.

Clayton, of Odessa, Fla., searched online for alternative lenders and found Prosper.com, which facilitates loans among individuals.

"I think it's a really good concept," says Clayton, 40. "People understand this because they're used to eBay and PayPal."

At a time when social-networking sites have taken off and trading on eBay has become a national pastime, the idea of borrowing from peers — rather than from banks or credit card companies — is gaining appeal. A handful of companies provide peer-to-peer lending, with each offering its own twist.

Several advantages

Borrowing money from your peers has its perks. You might be able to secure lower rates than what financial institutions charge for unsecured loans. (That said, if you owned a home and could get a home-equity loan, you'd probably get a lower rate than you could get borrowing on peer-to-peer sites.)

This type of lending isn't for everyone in need of unsecured cash. Most peer-to-peer sites limit the amount you can borrow. And there are generally more borrowers than lenders online, so not every loan will be funded. In addition, those who are more comfortable tapping the generosity of family and friends have little need to seek out these sites.

"There's only so much capital out there," says Jean Garascia, an analyst at Javelin Strategy & Research. "The (online) community is basically calling the shots and figuring out who's going to get loans."

The main reasons why borrowers turn to peer-to-peer lenders? They want to find low interest rates and to avoid piling up credit card debt, according to a November survey conducted by Javelin.

Some peer-to-peer lenders are more exclusive than others. Virgin Money facilitates loans among family and friends, rather than strangers. Virgin says that avoiding eBay-style loans among strangers allows lenders on its site to feel more comfortable issuing large amounts, such as the down payment on a home.

Lending Club and Zopa offer loans only to those with minimum FICO credit scores of 640. (Scores range from 300 to 850, with 850 being the best.) Even with a good score, though, Lending Club will accept only borrowers with what it regards as manageable debt. The two companies say their policy reduces the risk of default for lenders.

Lending Club also tries to connect borrowers and lenders who have like-minded interests — those from the same school, say, or who work for the same company — to "increase accountability," says Renaud Laplanche, founder and chief executive of Lending Club.

Prosper is the most laissez faire of the peer lenders: It allows almost anyone to borrow and lend on its site, after it checks that person's credit and verifies his or her identity. At Prosper, borrowers with the worst credit scores could be stuck with rates as high as 30%, if they're funded at all. Consumers with great credit might be able to receive rates of 7%.

"We think it defeats the purpose if you have to know people" to borrow and lend money, says Chris Larsen, Prosper's CEO. "It's kind of like on eBay. If you can only sell products to family and friends, we think that doesn't lead to the best prices."

Zopa, a peer-to-peer lender that started in the U.K. and began operating in the USA this month, probably has the most unusual model: Borrowers with good credit can get a loan from one of six credit unions that partner with Zopa. And people looking to earn interest on their savings can buy one-year FDIC-insured certificates of deposit from the credit unions. The CDs pay rates of up to 5.1%.

By buying a CD, lenders can help a borrower — whom they choose based on the person's Zopa profile — reduce payments on a loan. Essentially, the lower the rate the investor accepts on the one-year CD, the more the borrower's payments will be reduced each month.

Liz Rizzo of Los Angeles got an $8,500 loan through Zopa this month to pay off high-rate credit card debt that she says was "killing" her finances. Her loan payment on the three-year loan, at 9.9%, was supposed to be $180.56 a month. But so far, financial help from Zopa members has knocked $4.19 off her monthly loan payments.

Some people chose to help her, rather than other borrowers on the site, Rizzo says, because they identified with her struggle to pay off high-rate credit card debt she'd racked up in grad school.

"People are excited about this concept of helping people while making good money," she says.

Zopa's rates on one-year CDs also compare well with rates available on CDs at conventional financial institutions, making this investment appealing to a broad segment of consumers, not just socially minded people, says Douglas Dolton, Zopa's CEO. Overall, the average rate on a one-year CD is 3.5%, according to Bankrate.com.

For now, peer-to-peer lending makes up only a small slice of overall consumer borrowing. In 2007, an estimated $647 million in peer-to-peer loans will be made, according to Celent, a research firm. This pales when stacked up against the total outstanding consumer debt in the USA of nearly $2.5 trillion.

A potential threat to banks

Yet if demand for peer-to-peer lending continues to ramp up, it could eat into banks' and credit card issuers' market share.

"What you're doing is, you're circumventing financial institutions" by matching borrowers directly to lenders, says Keith Leggett, a senior economist at the American Bankers Association. "From our standpoint, (this issue) is on our radar screen."

Ultimately, more competition among lenders could benefit a broad range of borrowers. The growth of the market, Leggett says, could be a "a potential threat to your unsecured lenders, primarily credit card issuers, (which means) they'll just have to become more competitive" with rates and rewards given to customers.