As banks continue to tighten the grip on borrowers, canceling home equity loans and cutting borrowing limits on credit cards, Americans are increasingly turning to a timeless source of credit: one another. Person-to-person lending, facilitated by Web-based companies, is quickly coming of age.
"The credit crisis has put a huge crimp in the ability of the average consumer and the average small business to access credit from traditional sources," said Ed Kountz, a senior analyst at Forrester Research in Atlanta. "In a time of tightening credit, person-to-person lending has turned into an attractive alternative."
Borrowing from relatives is as old as the hills, but today's person-to-person lending market makes that loan more formal and accessible.
The market is dominated by three major players -- Virgin Money, Prosper and Lending Club -- although there are more than a dozen others.
These companies facilitate loans between friends and family by providing loan documents and automatic debits from the borrower's account. They also serve as matchmakers between strangers wanting to borrow and willing to lend.
The way it works varies from site to site, said Curtis Arnold, founder of CardRatings.com and coauthor of "The Complete Idiot's Guide to Person-to-Person Lending." That's largely because the market for this type of transaction -- also called peer-to-peer lending -- has gotten big enough for the companies to specialize.
Virgin Money concentrates on formalizing loans between people who already know each other. If you want to hit up your parents for a mortgage loan, for example, you can get them on a conference call with a Virgin Money representative and talk through both the interest rates and terms.
If you strike a deal, Virgin Money will then write up the paperwork and collect the payments. The cost for the service varies between $99 and more than $2,000, based on the complexity of the loan and how much you have the company do, said Tim Burke, social lending sales manager at Virgin. If you choose to have it process payments, Virgin Money also collects a processing fee each time a payment is made.
Virgin Money doesn't dictate the terms -- although it will provide warnings if the loan's interest rate is so low that it's likely to trigger tax problems or so high that you're likely to run afoul of state usury laws. (If you charge considerably less interest than market rate, the IRS considers the lost interest to be a gift to the loan recipient.) The rate and repayment schedule are set by agreement between the borrower and lender. No credit reports are necessary.
