The lender next door: Peer-to-peer loans gaining popularity
Spokane’s Richard Guzzard has lent about $12,000 over the past two years to people he’s never met. The retired assistant prison warden has shifted to peer-to-peer lending as his preferred source of retirement income.
Guzzard, 70, and his wife, Rita, moved from California to Spokane seven years ago. He has retreated from investing in the stock market, noting his wife’s 401(k) plan lost $30,000 in the past few years.
He laughs at the minimal 0.5 percent to 2 percent returns he could earn with CDs and money market funds. Instead, he uses Lending Club, a peer lending website. “It’s a no-brainer,” he said. “I’m making just about 8 percent (return).”
Despite initial regulatory bumps that led to the requirement that such sites register as sellers of securities, the peer lending industry is starting to take off. As banks have tightened access to credit and more people are looking for ways to reduce their personal debt, it connects prospective borrowers and lenders without involving traditional financial institutions.
Guzzard has made about 400 loans using Lending Club, considered the leading company in the peer-to-peer loan industry. He’s among several thousand people around the globe choosing to make small loans to a host of borrowers whom they’ll never encounter in person.
The Lending Club system lets Guzzard choose from thousands of loan applicants seeking from $1,000 to $35,000. Like most investors on such sites, Guzzard avoids large loans. He invests between $25 and $50 per “note,” the term used by Lending Club.
Spreading his investments across dozens of applicants reduces the amount of money exposed to possible default, he said.
Guzzard recently lent money to an Army veteran asking for $10,000 to become a partner in a service station. “I like knowing I can help people,” he said.
But he sees bizarre requests as well. “The strangest was someone looking for $25,000 to move to Bosnia,” he said.
Applicants must list limited information about themselves and their planned use of the loan. No names or exact addresses are listed.
Growth tied to recession
Over the past five years, U.S. residents have borrowed more than $633 million through Lending Club and its chief rival, Prosper.com. Both firms make money by taking a service fee and origination fee for each loan.
The major risk is borrower default. Lending Club says its default rate is about 3 percent. Prosper’s default rate is 5 percent. Both companies turn defaults over to collection agencies. Failures to repay end up on the borrower’s credit record.
When a borrower defaults, investors eat the losses because loans are not secured or backed by collateral. Guzzard said a dozen of his loans have defaulted.
The growth of peer-to-peer lending is clearly tied to the recession, said Teresa Lemmons, executive director of Washington State Microenterprise Association, a Federal Way nonprofit that helps arrange financial investments for startups across the state.
Interest has grown as it’s become harder to get traditional credit and people have struggled to shrink their own debt, she said.
Jesse McGrew, of Spokane, and Meghan Finley, of Coulee Dam, used Lending Club in the past year to consolidate credit card debts of $8,000 and $10,000, respectively. Both obtained loans that cut double-digit card interest rates to less than 8 percent.
McGrew, a 29-year-old computer programmer, has also begun investing on Lending Club. He’s made fewer than a dozen loans so far and plans to continue.
For borrowers such as McGrew and Finley, a key attraction is the speed of the transaction. Applicants sign up and allow a credit history search. Anyone with a credit score below 660 is disqualified; all others find out within minutes what their loan terms are.
Each loan’s interest rate and repayment period vary based on credit history, current debt, job history and other factors. Repayments run three to five years.
Peer lending companies assign each loan a letter grade, from A-1 for best credit, down to G-5 at the low end.
Investors can search for safer loans, paying 5.9 percent to 7.8 percent returns in the A or B categories. Or they can fund loans in the D to G categories, with higher returns.
Personal information often makes a difference in gaining investor interest. Greg Dawson, a 31-year-old Vancouver, Wash., resident, applied for $5,000 four years ago on Prosper. He said he got the loan quickly because he offered detailed information about plans to start a photography business.
“I didn’t have collateral when I went to the bank and couldn’t get a loan. But what worked for me was being able to tell my story online,” Dawson said.
Some investors email queries to applicants to learn more about personal finances or to seek out specifics before approving loans. Guzzard said he hasn’t done that. He does, however, screen loans to find those with government jobs and who’ve been employed five or more years.
Lending Club’s biggest share of loans – 64 percent – are for credit card debt consolidation. The next-largest category is home improvement.
While some believe peer lending will become much larger, the banking and financial sector sees it as just a blip on the radar.
“Based on the meetings I go to, I don’t hear anything about this (industry) posing a strategic threat to what we do,” said Scott Adkins, vice president of lending at Spokane Teachers Credit Union.
That’s due to the fairly small volume of funding peer lending companies provide, compared to banks and credit unions, he said.
Adkins said banks have mostly pulled out of the microloan market – loans under $5,000. But most credit unions, including STCU, still focus on that part of the market.
If anything, the lure of higher returns may be pulling money out of bank accounts and stock portfolios as investors seek better returns from peer lending, he said.
“It’s even crossed my mind” to invest in peer lending, Adkins said. Since it involves unsecured risk, he suggests people do that only to diversify investments.
“If you have discretionary funds to invest, that might be worth pursuing,” he said.