You need a loan but the bank has turned you down. It happens a lot these days. Banks have raised lending standards and any little blemish on your credit history can blow you out of the water.
But this is the Internet age, and where there is a need, there is usually someone online, willing to meet it. So it is with peer-to-peer lending.
In peer-to-peer lending, a group of investors acts as the bank. They loan their money to borrowers and receive interest payments in return. But how do you find a peer-to-peer lender and, more importantly, how do you persuade them to make a loan if the bank won't do it?
Tell your story
While the bank looks strictly at your credit score, and wants it to be very high, researchers at Rice University and the University of Delaware say a peer-to-peer lender is more interested in your story. If you have a credit blemish or two, but can explain the reason, they'll listen.
In two new studies, researchers analyzed data from Prosper.com, America's first peer-to-peer lending marketplace with more than a million members; borrowers and lenders can connect there without going through a bank or institution.
Borrowers choose a loan amount, purpose and post a loan listing. Then investors review loan listings and invest in those that meet their criteria. Once the process is complete, borrowers make fixed monthly payments and investors receive a portion of those payments directly to their Prosper account.
In the first study, the researchers – Scott Sonenshein and Utpal Dholakia from Rice University's Jones Graduate School of Business and Michal Herzenstein from the University of Delaware -- found that micro-lenders were more likely to offer loans to borrowers who explained, and then admitted or denied, the details of their credit history.
For instance, a borrower increased her/his perceived trustworthiness and chance of securing a loan by telling a lender, "I missed several payments on my car loan, which led to an increased interest rate, but I'm paying on time now and have learned from my mistakes" even though there was no evidence to support the claim that the borrower learned from past mistakes. Indeed, 65.3 percent of all loan requests that included such similar statements were funded, compared with only 45.8 percent of the loans that did not include such statements.
"Despite a poor credit grade, the social accounts that borrowers give and identities they create can increase their chances of securing a loan," said Sonenshein, lead author of one of the studies and assistant professor of management.
In the second study, Sonenshein and his co-authors analyzed the six different identities – trustworthy, successful, economic hardship, hardworking, moral and religious – that borrowers constructed for themselves in the loan application's optional essay. They found that borrowers in their sample could lower their costs by almost 30 percent and saved about $375 in interest charges by using a "trustworthy" identity.
'Trustworthy' is best
By presenting themselves as "trustworthy" or "successful," applicants had a much better chance of getting the loan. Those who described themselves as "religious" were less likely to get a loan.
When selecting an identity, researchers say it's better to choose just one. Presenting yourself as a mix of identities – “hardworking” and “economic hardship,” for example, tends to be confusing. Statistics also show that applicants who had multiple identities tend to be more likely to default, making investors more wary.
Still, for a growing number of consumers, peer-to-peer lending makes it possible to get a loan, in large part by adopting many of the ways banks did business in the past.
"By analyzing the reasons borrowers give and the identities they construct, we can predict payback status over and beyond more objective factors such as credit scores," Sonenshein said. "In a sense, it offers a way of assessing borrowers in ways that hark back to the earlier days of community banking when lenders knew their customers."