The commercial banking industry has made billions of dollars worth of profit over the years by borrowing money from savers at interest rates between 1% and 5% and loaning the money out to borrowers at interest rates anywhere from 7% to 30% on credit cards, home equity loans, mortgages, and personal loans. If you’re loaning money to the bank, and the bank is loaning money to other people, why can’t you simply cut out the middle man and keep the bank’s profits for yourself? It turns out, you can.
The industry that enables savings account holders to cut the bank out of the lending process is called “peer-to-peer lending.” Instead of indirectly loaning money to borrowers through the bank, there are now a number of peer-to-peer lending marketplaces that allows savers to take the money they would have placed in savings accounts and loan it directly to borrowers. Although there is some risk involved if the borrower does not repay, many savers that have moved their money to peer-to-peer lending services are making between 8% and 12% back on their money.
It’s not a fair comparison to say that the interest rates that you get by making loans directly to other people through peer-to-peer lending marketplaces is the same as loaning money to the bank. When you put money into a bank, your money is FDIC insured and there’s no risk that you will lose money on the investment. When you “become a bank” and lend money to borrowers via a peer-to-peer lending marketplace, you are taking on all the risk of default that a bank would when they make a loan.
If you are interested in “becoming a bank” your first step is to visit one of the websites for two major peer-to-peer lending marketplaces. If you are located outside the U.S., there may be a peer-to-peer lending marketplace specifically to your country. In the United States, Prosper Marketplace and Lending Club are the two companies that serve as an exchange for savers that want to “become a bank” and borrowers that would like to take out a loan.
After creating an account on Prosper or Lending Club’s services, you can then transfer funds in just as you would with any brokerage account. After you have money in your account, you can then start looking at loan listings and choosing which borrowers you would like to loan money to. In this part of the process, you are literally acting as a “loan officer” for the bank that you have just become. You need to look at each borrower’s listing and decide if you would like to fund a portion of their loan.
Common strategies that investors use to determine how risky a borrower is include looking at the person’s employment history, their credit rating, their amount of late payments, and the reason for their loan. Some choose to look at riskier loans in hopes of making higher rates of return and others play it safe and only invest in “A” quality loans.
No one is sure whether or not these peer-to-peer lending marketplaces will survive and thrive long enough to become a major part of the lending industry, but for now they are an interesting way for savers to take on a bit more risk and earn a much better rate of return than one would get on a savings account.
