personal loans

A peer-to-peer lending crash course for personal-loan borrowers

Businessmen exchanging money over deal © iStock

If you're short on cash, want to consolidate credit card debt or need a loan for home improvements, peer-to-peer lending sites could be a great way to borrow. Platforms like LendingClub.com, Prosper.com and Upstart.com offer a system where ordinary consumers can lend to each other through social networks.

These sites offer loans up to $35,000, come with favorable interest rates and feature terms of up to 5 years.

Whether a P2P loan is right for you depends on a variety of factors. These loans come with origination fees and may not be available in your home state. But they're also far cheaper than credit cards in many cases and could be an alternative for those without other low-cost, unsecured lending options.

Here are 7 things you need to know about borrowing through a P2P lending site.

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1. Yes, it's an official loan

Some consumers are skeptical of P2P lending because the loans don't come from a bank, which may make them seem less mainstream. Nevertheless, these are legitimate loans and no legally different than a loan from a bank. Because these sites sell securities (notes) to investors, they're heavily regulated by the Securities and Exchange Commission and are registered in every state in which they operate.

Banks traditionally take deposits and then loan that money out at an interest rate. P2P lending eliminates the middleman (banks) by allowing investors (depositors) to directly invest in loans (borrowers) while taking small fees in the process.

"They are highly regulated, much like a bank, and adhere to all federal (and state) lending laws. It's just a different structure," says Peter Renton, publisher of Lend Academy, an online guide to P2P lending.

Should a peer-to-peer platform shut down, consumers still are protected by regulations and lending agreements. Renton says loans would remain legally binding and simply be sold to another lender. "There would be no difference in your loan," he says.

2. The approval and funding process is a little different

Under a traditional lending scenario, a bank funds the entire loan approved for the borrower. With P2P lending, once the lending service approves the borrower, his or her loan is placed on the lending platform for consumer lenders to "invest" in the note.

Because investors like diversification and can invest as little as $25 per note, loans are usually funded by many peers. Simon Cunningham, founder of the lending guide website LendingMemo.com, says there are usually between 10 and 30 investors per loan, but sometimes up to 100. The borrower makes 1 monthly payment, which the platform then distributes to the lenders.

In theory, your loan could be rejected it if doesn't attract enough investors within a certain period of time, but Renton says that rarely occurs today.

"It was an issue a few years ago, but there are plenty of investors now. 99% of loans get funded," he says.

3. P2P lending may not be available in your home state

Because lenders also are regulated at the state level, not all P2P platforms are available everywhere. Cunningham says more states have gained access to P2P lending in recent years as the concept has attained legitimacy.

Yet, there are still some holdouts. At Lending Club, loans are not available to consumers in Iowa or Idaho. Prosper is not available to residents of Iowa, Maine and North Dakota. Consumers in West Virginia cannot borrow through Upstart. Between the approximately half-dozen P2P sites, borrowers in all states with the exception of Iowa still will find a few options.

4. Applying is easy, loans are usually funded quickly

You can apply for a loan online at any time and never have to visit anyone in person. Start the process with a "soft inquiry" with a few pieces of information and you'll have your interest rate in less than a minute. From there you can make a full application, which can take 15 minutes or less.

Depending on the loan amount, credit history and application, P2P lenders may or may not verify income. If your application requires income verification, you may need to submit W-2 forms or other tax records.

Cunningham says it usually takes borrowers 3 to 5 days to obtain approval and another couple of days to receive the funds.

"I've applied for loans on a Monday and have had cash in my account by Friday," he says. "It happens very quickly, and it's convenient. The (paperwork) is minimal, and you don't have to go anywhere."

5. You'll pay fees

Besides interest, you'll pay a bit just to borrow through a peer-to-peer lender. At Lending Club, origination fees are 4% to 5% for most borrowers and as low as 1% for A-grade borrowers. Borrowers with A-grade credit would pay $50 on a $5,000 loan, and those with the worst credit would pay up to $250.

Fees are deducted from the loan disbursement amount, added to the balance and start accruing interest immediately. So for a $5,000 loan with a 1% origination fee, you'll receive $4,950.

There are also late and failed payment fees. At Prosper and Lending Club, these are $15. Borrowers are hit with a late fee when their monthly payment is 15 days late, but no P2P platforms charge fees for early repayment of loan.

6. They're way cheaper than credit cards

Stu Lustman, commercial credit analyst and founder of P2PLendingExpert.com, says the primary reason people use P2P lending is to consolidate credit card debt and obtain a lower interest rate. "(Some borrowers) can save up to 10%, which is a tremendous savings," he says.

Low-interest credit cards carry an average rate of about 11.6%. Consider that a $5,000 balance with a minimum monthly payment of interest plus 4% of the balance would take more than 9 years to pay off. You'd pay more than $1,500 in interest over that time.

An A-grade borrower who pays off that balance with a 3-year P2P loan at 5.5% will pay about $435 in interest.

The other benefit of the P2P option is that it's a fixed loan with a fixed interest rate unlike with credit cards that carry variable interest.

7. It's an alternative if your options are limited

Renton says while P2P is "not for subprime borrowers," it could be an option for people who don't have access to a home equity line of credit or other lower-cost lending options.

Lower FICO scores are accepted but come with high interest rates. Requirements can change, but Renton says borrowers typically need a FICO score of 660 or above to get a loan on Prosper and Lending Club.

There are, however, other peer-to-peer sites that cater to borrowers with lower credit scores.

Avant, which specializes in "in between" borrowers, can work with FICO scores as low as 600. Peerform can also work with a 600 FICO score but also has higher APRs and its loans are available in only 36 states.

"P2P lending typically isn't for people with the worst of credit. For the most part, and for many options with a (decent) deal, you'll need a FICO of 660 and above," he says.

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