Some find loan window open to them: On the Web

A California resident who admits that her credit history is tarnished hopes to borrow $5,000 to pay down some credit card debt and buy four new tires.

A computer retailing and repair business in Michigan is looking for $7,500 to pay for marketing expenses. A Connecticut real estate investor wants $7,500 to buy a used mobile home for investment purposes.

In their search for credit, all three turned to an online “peer-to-peer” lending site.

For more than two years, Larry Filer has been sifting through the loan amounts, credit scores and other data for thousands of borrowers using the lending site Prosper.com. One of his questions is whether the availability of credit through this site might be fueling greater entrepreneurial activity.

The Old Dominion University economist already has noticed one striking development: The increasing wariness of banks to extend credit has prompted more individuals with strong credit histories to investigate online alternatives.

“This isn’t just the last stop for people who have been denied credit elsewhere,” he said.

Prosper.com is the largest of the nation’s major peer-to-peer lending sites. A handful of others have sprung up in recent years, including Lending Club; Zopa USA, the American version of a British lending site; and Lending Circle, whose name was changed to Virgin Money last year when Richard Branson’s Virgin Group acquired a controlling stake.

Each uses a different approach. Some, including Lending Club, are social-lending sites where friends and others who have a common bond can pool money for a borrower’s needs. Lending Club, for example, tries to link borrowers and lenders who share something in common, such as geography, education or a profession.

Zopa relies on partnerships with credit unions.

Virgin Money acts as an intermediary by handling payments for family members and friends who lend to other relatives and friends.

Borrowers using Prosper submit a request with the amount they are seeking, how they will use the money and details about their income and spending. Prosper shares the information, along with a credit ranking and a debt-to-income ratio, with its participating lenders.

Those interested in funding a particular request submit bids to Prosper with the dollar amount they’ll lend and the interest rate they want. Prosper combines those bids with the lowest interest rates into a single loan and sends the money to a borrower’s bank account. The site promotes loans with rates as low as 7.68 percent; however, they can be as high as 36 percent.

“It’s not unusual to have 50 to 100 lenders for a $6,000 loan,” said Tiffany Fox, a Prosper spokeswoman. Lenders limit their risk by diversifying their funds among several loans.

Loans are available through Prosper for as much as $25,000, but the typical amount is $6,000 to $7,000, Fox said. All loans are for three years and are unsecured. The largest single use is for debt consolidation; the next is business activity.

Filer, who teaches courses in macroeconomics and Federal Reserve policy, began studying peer-to-peer lending after doing research on personal bankruptcies. He found that the typical individual who filed for bankruptcy had a job and didn’t have enormous debt but lacked any savings to fall back on when hit by an emergency.

“If this individual had access to a short-term installment loan, could the bankruptcy have been averted?” wondered Filer, who plans to distill his findings on peer-to-peer lending into a paper for an academic journal.

The role that modest amounts of credit can play in people’s lives was highlighted two years ago when economist Muhammad Yunus and Grameen Bank in Bangladesh shared the Nobel Peace Prize. Yunus established the bank in 1983 to make tiny loans with flexible terms to destitute people in rural Bangladesh. He and the bank have been lauded for enabling many people to launch their own enterprises. Grameen replicas sprang up in scores of other countries.

However, the cost of handling small loans made such “microcredit” difficult to deliver in advanced economies where labor is much more expensive.

Prosper and other peer-to-peer lenders have devised sophisticated systems that reduce the processing costs and provide needed security for borrowers and lenders, said Jim Bruene, editor of the newsletter Online Banking Report.

“With U.S. consumer credit hitting $2.5 trillion in October, there aren’t a lot of questions as to the demand side for retail lending,” Bruene wrote in a December 2007 report on peer-to-peer lending. “It doesn’t matter who’s lending the money, there are plenty of takers.”

He estimated that the amount of peer-to-peer lending in the United States last year reached $86 million, three times what it was in 2006. If sufficient amounts of capital become available on these lending sites, the loan volume could surpass $1 billion in 2011, he predicted in the study.

How much of a threat could this pose for conventional financial institutions?

“It’s something that is definitely on our radar screen, and we’re watching it as we would any form of competition,” said Carol Kaplan, a spokeswoman for the American Bankers Association. The modest volume of lending done on the sites isn’t likely to displace the role of banks, she said.

Still, the London newsletter Retail Banking International called attention to peer-to-peer lending earlier this month when it awarded its annual “Most Threatening Non-Bank Competitor” designation to Zopa, the British lending network. Other nominees included Prosper and Wal-Mart.

One hurdle to sustained growth could be regulation. In the wake of investment banks’ heavy losses from mortgage-related securities, “this is not the time when regulators want to see newfangled lending instruments,” Bruene said.

Lending Club recently scaled back its lending and disclosed that it was working with the Securities and Exchange Commission to address the registration of notes it used in its lending. At some point, ODU’s Filer said, members of Congress, too, may step in with proposals for regulating this type of lending.

For peer-to-peer sites to thrive, they must attract lenders as well as borrowers.

When Prosper began operating in early 2006, some of its lenders were lured by the high interest rates that riskier borrowers were willing to pay. Many high-risk borrowers eventually defaulted, and some early lenders retreated. However, some sophisticated lenders profited handsomely by being better able to calculate the risks and avoid heavy losses, Filer said.

As data about borrowers becomes more available to lenders, the more venturesome ones may lose their edge and leave Prosper for more lucrative investments, he said.

Peer-to-peer lending through Prosper will continue to grow, Filer said. However, he expects social concerns to supplant lenders’ profit motive. In other words, people will be more inclined to lend for a borrower’s welfare.

“My gut instinct,” he said, “is that this will revert very much to social lending.”

Tom Shean, (757) 446-2379, tom.shean@pilotonline.com