Person-To-Person Loans - You Can Earn Better Returns

Person-to-Person lending (also known as Peer-to-Peer or P2P) is fast becoming an attractive way for borrowers and lenders to connect directly. It is like the EBay of the banking world. In the past, you would deposit your funds at the bank and depending on the amount and term, the bank would pay you interest. Current certificate of deposit rates range from 3.50% to 5.00% APY. Basically, the bank then makes loans with your funds and their income is based on the spread between your rate and the loan rate. Well, why let the bank have all of the fun? Now, you can lend direct and earn more interest.

There are three main services: Prosper.com, LendingClub.com, and Zopa.com. Prosper gives you plenty of details such as the credit score, Debt-to-income ratio, etc., so you can make informed lending decisions. Prosper.com allows the lender to seek additional details about the borrower, although the borrower doesn't have to respond. Of course, then the lender doesn't have to lend to them. Many lenders spread out their funds in $50 to $100 increments to minimize overall risk. Looking at data from Prosper (6/1/06 to 4/21/08), average rate of return for AA borrowers is 6.64%. Some people sprinkle in some lower quality loans to try to bring the return up. Your funds aren't guaranteed, however. With Prosper you can get started with $50.00. Certainly not much to risk, to get your feet wet.

Lending Club isn't currently accepting new lenders. The site says, "Lending Club has started a process to register, with the appropriate securities authorities, promissory notes that may be offered and sold to lenders through our site in the future." They use a system they call LendingMatch to suggest a portfolio of loans to the lender. It takes various aspects of your profile and matches you with borrowers that you may have a "connection" with. That connection can be you both like dogs and are MySpace addicts. The lender can override the suggestions and make their own decisions.

Zopa operates a little differently. They tie your investments in with an NCUA insured CD. They partner with various credit unions to accomplish this. As a result, your funds are insured up to $100,000, but the earnings compare with 1-year CDs. Currently they are advertising 3.75%. The minimum required to start at Zopa is $500.00. Zopa has a feature where you must agree to help at least one borrower out. You do this by reducing your earnings rate and as a result, reducing the borrowers loan rate. People helping people is the true theme of all three services. The fact that everyone mutually benefits makes it very rewarding.

I don't think the person-to-person lending will replace other investment alternatives, but I do think it can add some return to a well-balanced portfolio. If you manage your lending portfolio well, the returns are certainly attractive compared to other investment vehicles. Our specialty will remain with quality, guaranteed returns in certificates of deposit, but I certainly believe putting some extra funds at Prosper or one of the other services is a good idea.

For more information visit our Peer-to-Peer lending section on our site.

Chris Duncan is a FINRA Registered Representative. He specializes in helping clients find the highest and best CD rates nationwide. His clients include individuals, financial institutions, corporations, and public agencies. Please visit our Certificate of Deposit Rates page.