Strangers are filling gap for people needing a loan when traditional lenders aren't an option.
Michael Preston was in the final stages of putting a two-story addition on his Bellingham home when he hit the limit on his home-equity credit line. He needed $12,000 more to finish the job. So he got 140 complete strangers to pool their resources and give him the money.
He found his funders on LendingClub.com, one of many Internet-based loan-intermediary companies that has sprung up. The sites enable ordinary people to easily find, bid on and invest in other people’s personal loans. This setup is known in the industry as peer lending, and it’s become a popular way to find money for real-estate purchases.
There’s substantial money flowing to real-estate projects through peer loans. At another popular lending site, Prosper.com, $191 million in loans have been funded since 2006. Company spokeswoman Tiffany Fox estimates as much as 20 percent of its loans are related to real estate, mostly home-improvement projects.
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A search on Prosper found 65 current listings for real-estate related items nationwide. Reasons for seeking the loans included making needed home repairs before a sale, adding a media room and making a first-home down payment in time to qualify for the stimulus tax credit
Preston says he found LendingClub on an Internet search for loan alternatives, and found its process easy and fast, with far less red tape than a bank loan would have carried. He had his loan in hand within a couple weeks of filling out his paperwork, despite a less-than-spotless credit history. In the current lending environment where many banks have pulled back on real-estate lending, a peer site can be a good alternative.
“I had looked at other options, and a lot of lenders were being tight with their money, even local credit unions,” Preston says.
Essentially, ordinary people with cash to lend act as the banker on peer-lending sites. Lenders get the opportunity to earn higher interest rates than they’d get in a bank savings account or certificate of deposit by funding borrowers’ loans, while shouldering the higher risk that borrowers will fail to make their payments. The lending sites take a small percent of the loan amount from borrowers as their fee.
Interest rates for borrowers tend to be on the high side; Preston is paying just under 12 percent interest on his loan. He plans to refinance and pay the LendingClub loan off once he’s done remodeling.
The higher interest rate is better than getting no money, which is a lot of people’s situation right now. The loan can also be better than a credit card because one missed payment there and your rate can go to the sky, where on a loan you pay a small late fee but it doesn’t change the terms.
And if you find a better deal, you can pay it off early; there’s no prepayment penalty. People also use peer loans to establish credit or rebuild their credit history.
Loan sites screen borrowers, assign them a credit rating, and then allow potential investors to review their story. If an investor wishes, they participate in the loan, usually putting up just $25-$100 per loan to spread their risk. Some investors set up predefined parameters for lending and the site automatically invests them in loans that fit their requirements.
Investors name the lowest interest rate they’d be willing to pay on the loan, and the site determines the lowest rate where enough lenders are willing to fund. That rate becomes the loan’s interest rate, and the lending site then packages the loan and oversees the loan until it’s paid off.
Terms are usually three years, and most sites will lend up to $25,000. State laws cap interest rates for non-real estate loans; in Washington state the cap is four points above the trailing average Treasury bill rate, or 12 percent now.
As with a bank loan, if a borrower falls behind on a peer loan, the lending site will send the account to a collection agency. Deadbeat borrowers risk damaging their credit rating.
Each borrower gets a profile page where they explain their reasons for seeking the loan. They also describe their finances and how they will have the means to pay back their loan. Lenders can ask borrowers questions about their loan through the site if they need more details.
Snohomish Valley farmer Kurt Bartelheimer says he answered a half-dozen questions on LendingClub when he needed $9,500 to buy seed and 125 additional acres for growing barley, wheat, canola, corn and mustard. His loan funded in August at 16.35 percent interest.
“I work full time for the fire department, so they wanted to know when I would have time to farm,” he says. “I explained I work two days on, four days off, so it’s only eight days a month.”
Belfair retiree Bob Dollar likes using Prosper.com when he has small remodeling projects to do around his home. He got his second Prosper loan in November. The $2,500 loan helped Dollar pay for sewer repairs and a new deck.
“It really works well, and I got a fair interest rate — 8 percent,” he says. “I’ll do it again.”