Lending gets personal
By Blake Eligh • Bankrate.com

Garrity says the typical social lender actively manages his own investment portfolio and is looking to P2Ps for a complement or an alternative to other investments. "If you look at the returns of the equity market, mutual funds and even bonds to a certain degree, we have had a relatively low yield year," he says. "I think investors will see pretty significant appeal in the way our asset class performs."

P2P providers assign borrowers to a risk category based on a borrower's credit score. That category dictates the range of interest rates to be paid on loans and also lets lenders make informed decisions about where they invest their money. Most sites limit the total loan to about $25,000 over a three-year term. Lenders are also encouraged to diversify their portfolio so they don't get burned if a borrower defaults. In return for administration, the P2P service provider takes a cut of the action -- from one to three percent from borrowers and zero to one percent from lenders.

Community chest
P2Ps also promise to harness the financial power of social groups by drawing on personal connections between lenders and borrowers. Community members of Prosper's Duke University alumnae group trade funds back and forth united by a common connection. Other groups are based on location, faith, ethnic background or even favourite sports teams. Others may use P2Ps as a way to formalize loans between friends and family.

Garrity says self-identified communities can use the site in a meaningful way to help and profit from each other. Borrowers get to help out a personal connection in a formal agreement, complete with options to call in a collection agency if a borrower defaults, although some analysts theorize that the common connection may cut down on default rates.

Pennywise
P2Ps paint a rosy picture, but there are risks. American P2P providers boast very low default rates -- less than one percent -- but the industry is still young. And critics charge that the anonymity of the sites attracts borrowers with dented credit histories, and the anonymity of working online frees borrowers to fib about their requests.

Good P2Ps have checks in place. Borrowers are vetted through verified personal information, including credit history. Some of that information is provided to prospective lenders.

"With any investment, there are risks," Garrity says. "Our job is to ensure that we disclose risk in a way that is compliant with law and responsible to our community and manage risk on behalf of the lender community that is investing."

If borrowers default on a debt or miss a payment, most P2P services will report that to the credit bureaus, and borrowers will be charged a late payment fee. They will also send a collection agency after outstanding money on a defaulted loan.