fails to renegotiate or recompense the lender
for the shortfalls.
Conventional lending laws and holder-in-due-course laws vary from state to state.
Thus, in some jurisdictions the lender may
seize and sue; in others the lender must make
a choice. It also depends on the security; e.g.,
a house that is occupied cannot be seized
under Florida bankruptcy laws. In other jurisdictions, an occupied house may be seized.
die when lenders frustrated with poor results
Larsen disagrees. “We see even more cred-itworthy borrowers coming to us,” he says.
“Our default rates are declining as our growing base of data allows potential lenders to
estimate risks. More mainstream customers
are coming to borrow at Prosper and other
P2P companies, and lenders are getting better
at choosing their borrowers.”
Fewer rules, lower costs
There are several models of peer-to-peer
lending, but all use the Web as a marketplace.
For the most part, P2P sites are just intermediaries, and most do not actually handle the
money. “The success of eBay’s auction process
was the model for what is now sometimes
called social lending,” Larsen notes.
Prosper.com started in February 2006. It
rates potential borrowers’ credit via scoring
based on credit history, sets rules for payment, documents loans and tracks repayment. It is unlike a bank in that it does not
lend its own money and therefore does not
operate with the elaborate rules and costs of
a conventional lender.
Lending Club in Sunnyvale, California, is
another P2P lender. Unlike Prosper, which has
an interest-rate auction process for matching
lenders and borrowers, Lending Club offers
fixed rates that vary with the quality of the
loan—that is, the credit history of the borrower. On a recent Web posting, its interest
rates started at about 7 percent for top-grade
borrowers and rose to as much as 17 percent
for borrowers with poor credit histories.
P2P loans require the borrower to complete an online application. Personal information enables the Web site to generate a
credit score. The applicant tells his or her
story to bolster the application. The money
may be for business purposes or personal
things such as credit-card repayment, a car
loan or home renovation. Most people,
Larsen says, are wise enough to avoid asking
for loans for frivolous things.
Some applicants include a budget that
breaks down how the loan will be used. It
adds to credibility, because it gives the lender
confidence, Larsen suggests. Low-risk loans
get the lowest rates, of course. Larsen notes
that small businesses are major users of
Prosper, with 30 percent of all loans being
used for commercial purposes.
Potential peers pervade public
Variations on the P2P model are thriving.
Zopa.com, a P2P service whose name is a
contraction of Zone of Possible Agreement,
are for working capital and inventory acquisition. It can be a trucker who is buying equipment, a tutoring business that needs money
to pay its bills when its receivables are slow to
arrive or a delivery service that is using the
money for startup costs. In every case, it is
essential for the applicant to tell and indeed to
sell his or her story.”
Those stories, which are available to other
members, can be a basis for small contributions that lenders can make to what they think
of as worthy cases. Those contributions reduce
what is owed and effectively lower the interest
rates on loans.
Dolton says Zopa quickly makes loans to
qualified persons on application without forcing them to wait a week or two. Contributions
can exceed loan payments in a few cases, he
adds. Though the model differs by country, in
the U.S. Zopa’s money comes from participating credit unions; other P2P lenders are more
like matchmaker services between potential
borrowers and lenders. In every case, they are
ways for people to help people, Dolton notes.
Bigger players for bigger loans
One of the more interesting players in the
social-lending industry, Virgin Money USA,
based in Waltham, Massachusetts, was called
Circle Lending until it was bought in 2007 by
British entrepreneur Richard Branson.
Explains CEO Asheesh Advani, “We founded
the company to work with friends and family
members who loan money to one another.”
Virgin Money confers formality and regularity on informal loans. The company has
helped to originate $300 million of loans for
tens of thousands of clients, including business loans through a product called Business
Builder, Advani says. “In the case of business
loans, Virgin Money certifies that the borrower is a business and reviews the articles of
incorporation or other documentation,” he
explains. The range of loans handled goes
from $500 to $500,000, and a quarter of all of
its loans are business related, he says. Virgin
Money is really about handling the details
and paperwork for deals already agreed to.
—Chris Larsen, CEO,
Bad loans for bad credit?
For lenders, returns of as much as 20 percent have been generated on loans to high-risk borrowers, though with a substantial rate
of late payers or defaulters. Critics of the system say e-loans appeal mainly to people with
bad credit histories rather than to those who
have good credit and need quasi-banking services. The critics say that the P2P model will
operates in the U.S., Britain, Japan and Italy.
Zopa provides small loans in a range of $1,000
to $25,000 using conventional credit-scoring
techniques. Started in London in 2005, it was
the first P2P company, says Douglas Dolton,
Zopa’s CEO and head of global operations.
“What we have launched in the U.S. is
unique,” Dolton, a Costco member, explains.
“We empower borrowers to lower their interest rates. We estimate that about 25 percent of
our loans are for small-business purposes,
though they are all done on personal credit
scoring. We see that most of the loans we do
Thinking outside the bank
P2P lending is replacing the idea that
banks are known by their buildings. But the
old rules still apply. If a borrower does not
repay, the lender winds up with a loss. And a
delinquent borrower will find that the next
loan he wants will be declined. As Chris Larsen
notes, “Trust and honoring commitments
remain the foundation of lending.” C
Andrew Allentuck writes about personal
finance for the Toronto Globe and Mail.
His latest book, When Can I Retire? Planning
Your Financial Life After Work, will be published in January 2009 by Penguin Canada.