Loan sharks take note. There's a new lender in town and they don't break your legs when you get behind on your payments. Lending clubs, or what used to be known as peer-to-peer lending, appear to be growing in popularity as banks remain stingy with their credit and only loan money to those with pristine credit and high FICO scores.
Peer-to-peer lending began as a way for cash-strapped entrepreneurs to start a new businesses, expand an old one, or for people trying to consolidate their high-interest credit card debt (the new loan shark) but don't have credit scores high enough to get a home equity loan.
So they find a peer-to-peer lending group that will let them rollover their credit card balances that are charging anywhere from 14% to 29% into loans that charge 11%.
One such place is appropriately called the Lending Club at www.lendingclub.com. Over the past three years, it has matched 23,000 lenders with 18,500 borrowers. It has a total outstanding balance of $179 million, which is small potatoes when compared to banks and credit cards.
Lending Club was founded by Renaud Laplanche in 2007. It was one of Facebook's first applications, which helped attract mostly young borrowers who had poor credit histories or no histories at all.
Today, Lending Club is one of a number of peer-to-peer lenders who fill the gap created between banks loaning to only those with a great credit history and the millions of others who don't but who still need to borrow money. Another peer-to-peer lender is a company called Prosper at www.prosper.com. It holds competitive auctions in which lenders bid to offer borrowers the lowest interest rates. It claims to have over 900,000 borrowers.
Lending Club puts potential borrowers into 35 categories or levels based on their credit histories and other data. To qualify, a borrower must have a minimum FICO score of 660, a debt-to-income ratio (excluding mortgage debt) of less than 25% and no current delinquencies, recent bankruptcies or tax liens. They're not completely stupid. In fact, Lending Club rejects roughly 90% of prospective borrowers.
Creditors can choose which individuals to lend to and commit as little as $25 to loans whose total values range between $1,000 and $25,000. They can also become creditors in baskets of loans to debtors of various risk levels.
Lending Club charges borrowers upfront fees and pockets a spread between the interest lenders earn and the higher rates that borrowers pay. It expects to earn $7 million this year and triple that in 2011.
One of the lenders, Craig Jones, is a venture capitalist, who joined the club while waiting for the IPO market to return. In the meantime, he puts up $1.2 million, or one-fifth of his investment portfolio, to be used as loans.
How's he making out? When you compare the return you get to a high-yielding bond, let's say a five year B-rated corporate bond that pays 7.5%, with defaults averaging 3.4%, lenders at the lending club earn on overage 9.6% once you strip away defaults and the lending club's take, according to Laplanche. These days, that's not a bad return.