Hey, Buddy, Can You Spare $10,000?

By Jeninne Lee/St. John

The slumping economy has sent the banking system into panic mode, making it tough for even people with the best credit rating to get a good interest rate. So a rising number of folks looking to consolidate debt, buy an engagement ring, finance their small business or pay off a mortgage are using the Internet to ask for help from a friend or, more often, a stranger.

The nascent peer-to-peer (P2P) loan industry, in which regular people exchange cash with the help of an online facilitator, had about $650 million in outstanding debt in 2007. Prosper, the first such matchmaker in the U.S., which started in 2006 and now has 600,000 users, and Lending Club, described below, are sort of financial eBays: borrowers post a request, and lenders bid on how much and at what interest rate they want to give. Several--or several dozen--people fund the loan at a rate agreeable to all. The intermediary runs a credit check, calculates returns and takes a fee.

It might sound like a setup for another subprime-mortgage debacle. But so far, Lending Club's default rate is less than 0.5%. That's partly because P2P members are motivated to pay back or lend to an actual person rather than a big bank. Since May 2006, Marilyn Paguirigan of Honolulu has lent a total of $30,000 to more than 100 people on Prosper, most of whom she has never met. "I measure my returns in not just the dollar amount," says Paguirigan, who happily makes 6% to 7% on her loans. "It's in the fulfillment I get from helping people." Here's a typical P2P loan:

THE BORROWERS

Seeking a Cheaper Loan

1 HOW IT WORKS: Borrowers need credit scores of at least 640 (of 850 maximum) and a debt-to-income ratio of 30% or less.

WHO DOES IT: Even with credit scores in the 700s, Cristieli Schemidt and Rafael Ferrer of Davie, Fla., could not get an interest rate below 15%. In October they took most of their debt--$5,000--to Lending Club. They pay $136 a month at a fixed 11.41%.

"We were so frustrated with the credit companies," says Ferrer. "Now we're free."

THE ONLINE MIDDLEMAN

Making the Connection

2 HOW IT WORKS: The average loan is $9,500, funded by 22 to 25 people.

WHO DOES IT: Lending Club, which launched last May, relies on fairly strict rules and works with people in affiliated groups, matching up, say, travel agents or MIT alums with peers.

"The connections not only help persuade lenders to participate," says founder and CEO Renauld LaPlanche. "They also make borrowers more responsible and more accountable."

THE LENDER

Looking for a Higher Yield

3 HOW IT WORKS: Lenders list the total amount they'd like to loan and the risk level they can stand. They can select individual borrowers who meet their criteria, or the site's Lending Match program will generate a portfolio. The mean 12.32% interest rate beats the current 3% average return on a CD.

WHO DOES IT: Bernadette Lui of San Jose, Calif., has $3,125 spread among 13 three-year loans. She earns 14.6% and is considering reinvesting her returns with new borrowers.

"They're pretty small dollar amounts on each loan," Lui says. "I figured it would be acceptable if someone defaulted."