Peers provide alternative to traditional bank loans (2024)

Over a span of seven years, Helena VonVille's mother developed Alz­heimer's disease, and her two dogs fell ill with cancer. She relied heavily on credit cards to pay veterinarian bills and purchase plane tickets to see her mother in Ohio.

"I just ended up racking up more debt than I'd realized," the Texas Medical Center-area resident said. "You know, there was a point where I would look at my credit card bill and just go, 'Oh, my God, what have I done?' "

So she went to Lending Club, a website where consumers request loans and a variety of individuals invest to fund those loans, to considerably pay down this debt. The loan's annual interest rate of 7.99 percent is lower than what her credit card charges.

She now pays the majority of her credit card bill each month and has increased her savings for retirement. As for the loan, VonVille said she never considered trying to borrow from a bank.

"I just didn't think they would help out," she said. "I mean, my credit card's through a bank. So why would they want to turn around and give me a loan to pay off something where they're getting more interest out of me? I just didn't even consider it."

Alternatives to banks

VonVille, 57, is one of many Houston residents choosing peer-to-peer lending, crowdfunding and other alternatives in lieu of mainstream banks and credit unions.

These types of funding - often used to pay down credit card debt, finance large expenses or raise capital to start or build businesses - are growing in popularity.

"They're filling in some of that gap by providing these loans," said Stu Lustman, who blogs at p2plendingexpert.com. By day, Lustman is a commercial credit analyst for a small equipment leasing finance company in Atlanta.

Peer-to-peer lending enables borrowers to request online loans through sites such as Prosper.com and LendingClub.com, which approve loans and set interest rates. Once the loan and financial details are posted online, multiple investors contribute to fund it.

Each loan is given a letter rating and interest rate that reflect the loan's risk, with higher interest rates attached to riskier loans. Investors sort through the data and choose where to invest.

Lending Club and Prosper Marketplace also have options for investors to set criteria and the lending companies will find matches for them.

Tom Lykos, Houston-based managing director on the Private Equity team of Commerce Street Holdings, said more people are considering these alternatives as access to funds is more important than the cost of those funds.

He said regulations intended to benefit consumers, such as credit card reforms and the Dodd-Frank Wall Street Reform and Consumer Protection Act, have caused banks to be more cautious in the area of consumer lending. These concerns, he said, are driven by regulation more than the creditworthiness of borrowers.

"I think those who need credit are looking for alternative sources," he said.

Both sides benefit

Peer-to-peer lending allows borrowers to pay off credit card bills with relatively lower-cost loans, Lustman said, while offering investors higher returns than government bonds or savings accounts.

But there can be drawbacks. For one, he said there's not much liquidity. Investors are stuck for many years unless they sell on a secondary marketplace.

He also said the loans are unsecured, meaning borrowers don't put up collateral, so there's the risk investors won't be repaid. He said this typically doesn't happen, and investors are encouraged to diversify their portfolios - which reduces their risk - by investing smaller amounts in multiple loans.

"I think it balances out overwhelmingly on the pro side," he said.

The annual default rate at Lending Club, for example, has been 2 to 4 percent since 2009. The company keeps default and delinquency rates low by issuing loans to individuals who have demonstrated an ability to handle credit responsibly and who have a minimum credit score of 660.

When a payment issue does occur, Lending Club's collection process is similar to that of traditional banks. It also reports information to consumer credit reporting agencies, which means paying down a loan can benefit borrowers' credit scores, and defaulting on a loan can hurt their credit scores.

Prosper's annual default rate in June was 2.1 percent. Borrowers who miss a payment by more than 15 days are charged a late fee, which is charged monthly if the customer remains past due. After one month, the delinquency is reported to the credit bureaus. After four months, the loan is charged off, and the balance is collectible in full.

So at both companies, borrowing behaviors can affect consumers' credit scores for better or for worse.

'A totally new way'

Prosper, which launched in 2006, originated $357.4 million in loans through the platform last year, up 133 percent from 2012 and 376 percent from a year earlier.

"It's a totally new way of interacting with money and credit," CEO Aaron Vermut said.

He said about 65 percent of borrowers use the money to pay off loans or debts with higher interest rates, such as credit cards. Vermut has also seen consumers use Prosper to start businesses or pay medical expenses.

But for now, he said, Texas residents and Texas-based institutional investors cannot invest through Prosper.

However, these lending companies must file an application with the board to determine whether the business plan is fair, just and equitable, according to a standard written response the board's registration division gives to those who ask about peer-to-peer lending.

Peer-to-peer lending companies must meet specific standards set forth by board rules. In particular, the board must determine whether the company has demonstrated the ability to satisfy its financial obligations and if they will be able to continue meeting future obligations.

Lending Club and Prosper filed applications at one point, but they both withdrew those applications

Prosper, in a follow-up email, said it withdrew the application because the board's response indicated it would have needed fundamental changes to its platform before being approved. However, both Prosper and Lending Club are hopeful that Texans will one day be able to invest through their platforms.

A desire to help others

VonVille said she would like to one day invest through Lending Club. She said it seems to be a good - and relatively simple - investment. Plus, she wants to pay it forward.

"I've benefited from it, so I like being able to help somebody else benefit," she said.

Lending Club launched in 2007. The dollar amount of loans issued through its platform has doubled every year, with Lending Club facilitating $800 million in loans in 2012 and $2 billion in 2013.

"What's driving the growth really is that borrowers are getting a better deal than they get at the bank," founder and CEO Renaud Laplanche said.

He said banks have even started using the platform. They've realized Lending Club can make loans at lower costs, he said, because it's a technology company and doesn't have a branch network to support.

This year, Lending Club also started offering small-business loans.

"We saw a pretty big need in the market," Laplanche said.