Comparing Apples and Oranges: Peer to Peer Lending and Savings Accounts.

Banks such as ING Direct and FNBO direct which were previously considered to be “high yield” savings accounts are now offering FDIC insured savings accounts at interest rates of barely 1%. Savvy consumers that shop around might be able to find rates closer to 2%, but it’s a far cry from the 5% rates that online savings accounts were handing out during 2006 and 2007.

As savers have become increasingly dissatisfied with the interest rates that traditional savings accounts at banks have been offering, many consumers have been looking for alternative places to put their money and get a higher rate of return. One of these places is the relatively new, but quickly growing peer to peer lending industry.

A number of personal finance bloggers have boasted earning between 9% and 15% APY by taking some of their savings and investing it by lending it to other people using peer to peer lending services including Lending Club and Prosper.com. These two services allow individuals to review loan listings from people that want to borrow money on the site and fund part of the loan amount. The lender receives interest on the loan as well as payments over a three of five year term, hopefully resulting in a better rate of return for the user.

It’s important to note that providing loans to other individuals directly through peer to peer lending sites and indirectly through a savings account and a bank are two different animals. With a savings account, the bank is taking all of the risk, as well as all of the reward. With a peer to peer lending website, you are taking on all of the risk by determining who you are going to give a loan to, but you also get the reward of potentially higher interest rates.

Although many Lending Club users have reported earning great rates of return during the few years, early Prosper.com users had a different experience. The company placed no limits in regards to credit scoring or what interest rates people could lend money at, resulting in a significant loss for some investors. Lending Club users have fared better to date, but it’s important to note that there is a level of risk in peer to peer loans.

The money that you lend through peer to peer lending websites is also much less liquid than money that you would put into a bank. You’re lending money over a three or five year term and it’s not a simple process of withdrawing your funds to get your money back before the term of the loan is up. Instead, you would need to sell the loans on the FolioFN note trading platform that Lending Club offers, which will allow you to liquidate your funds, but does take some time.

Your Lending Club or Prosper.com account shouldn’t take the place of your basic savings account because of the risk involved and relative illiquidity, but it might be a decent place to put some money if you’re willing to take on some additional risk and potentially greater reward.