I received several reader e-mails this weekend regarding the safety of person to person lending. I thought I would share these questions and the answers, so hopefully more people will better understand the process.

Regarding Person to Person lending do you know how they underwrite these loans? Do the borrowers have to provide credit scores? Can a non-payment show up on their credit report?

I like the idea, but I could see this blowing up. While I certainly don’t like how the credit card companies go after folks who don’t pay, it does tend to force compliance. What does Prosper do if folks default?

Kirk

Kirk, thanks for the question. I will break apart your questions below and explain the lending process, and how the P2P lenders make the process as safe as possible for everyone involved. I will use Prosper as an example, but Lending Club is very similar.

The Person to Person Lending Process

The lending process is set up just similar to a financial institution providing a personal loan to an individual. The loan is a legal loan and is reported to the major credit bureaus and there are collection agencies in the event of a default.

Borrower ID Verification: The borrowers provide all their financial information including SSN, date of birth, address, telephone number, and a bank account for verification. They also provide income level and profession. This info is used to verify the borrowers ID against anti-fraud and credit databases. Prosper does a full credit check to determine credit scores. On top of that, Prosper has a 100% guarantee against identity theft to protect borrowers and lenders alike.

Defaults: If a borrower defaults on a loan, it is reported to the major credit agencies and there are established collection agencies to go after the money for the lenders. A loan from Prosper or Lending Club is a legal loan, just as if it originated from a brick and mortar bank.

One small difference Lenders arent actually lenders. The loan is actually made by Prosper with their own operating funds when enough lenders have agreed to fund the loan. Once Prosper makes the loan, the lenders buy pieces of the loan. I put the word lenders in parenthesis because they are not actually lending money, they are buying a piece of the loan that Prosper made. At this point, you become a lien holder. The term lender is used because it is easier to identify with.

The P2P Loan Process is Safe

The loan you are purchasing is really no different than a bank underwriting an unsecured loan to another person. Security and verification measures are put in place, the loans are reported to and tracked by the major credit agencies, and in the event of a default there are collections agencies to help recoup your investment.

While the process is safe, there is risk involved. These loans are unsecured and not guaranteed. They have the same risk that a regular financial institution takes when they make an unsecured loan to an individual. However, the interest rates charged by the peer to peer lending companies are designed to offest the risk.

I invest in person to person loans

Right now I have several loans with Prosper and Lending Club. I am only investing funds that I can afford to put at risk. Just like any other investment, you need to do your research to determine the level of risk you are willing to assume and the percentage of your portfolio you are willing to invest.

The best way I have found to lend is to do your research to determine which borrowers might represent a low risk loan generally someone with a high credit score and a low debt to income ratio. While the loan isnt guaranteed, the returns can quite possibly be better than a CD or high interest bank account.

Try Peer to Peer Lending for little to no risk on your part

If P2P lending intrigues you, now is a great time to try it out with little to no risk on your end.

Prosper is also giving new lenders $25 to sign up, but you have to fund a loan before you get the bonus, and the minimum loan is $50. So, it will only cost $25 to try the lending process. Prosper also has a referral program, so you can again refer people and make money. Keep in mind the bonus is not paid unless the person you refer either makes a loan or borrows money.

Lending Club has currently placed their referral program on hold. Check back later for more details.