Peer-to-Peer Lending Makes Inroads in Bank Markets

YOUNGSTOWN, Ohio -- Peer-to-peer lending is gaining a foothold in the United States. While its market share is small, only about $3.5 billion outstanding, it is growing and two economists at the Federal Reserve Bank of Cleveland foresee its continued growth.

You haven’t heard of peer-to-peer lending? That’s could be because it’s so new. And because Ohio doesn’t allow it although the state Department of Financial Institutions reviewed this type of lending in 2011, one of the economists, Daniel Kolliner, said last week in a telephone interview.

Peer-to-peer lending, in brief, matches those who want to borrow money with investors who want to lend money. Among the firms -- call them matchmakers, if you will -- that unite borrowers and investors are Prosper Funding LLC, San Francisco; LendingClub, also in San Francisco; and Upstart, associated with Cross River Bank, based in New Jersey.

Upstart’s relationship with Cross River Bank is indicative of a finding of the other author of the Cleveland Fed report, Yuliya Demyanyk, that some community banks have formed partnerships with peer-to-peer lenders.

LendingMemo, an online financial publication, reports that LendingClub has gone from lending $20 million a month in October 2010 to $225 million last October and Prosper from $2 million a month to $50 million a month over the same period.

Late last year, Google invested $125 million in LendingClub, which has originated more than “$3 billion in loans to thousands of borrowers,” LendingMemo reported last January in “P2P Lending Sites: An Exhaustive Review.”      

In the Aug. 14 issue of Economic Trends, the two Cleveland Fed economists, Demyanyk and Kolliner, write that peer-to-peer lending first appeared in the United Kingdom in 2005 and came to this country in 2006.

“The peer-to-peer market has been growing rapidly since its inception,” they write, “while traditional consumer bank loans and credit-card lending have been declining. Since the second quarter of 2007, the total amount of money lent through bank-originated consumer finance loans has been declining an average of 2% per quarter and the total amount lent through bank-originated credit cards has been declining an average of 0.7% per quarter. Meanwhile, peer-to-peer lending has been growing rapidly at an average pace of 84% a quarter.”

Prosper will extend loans of $5,000 to $35,000, Kolliner says, and its website says its rates start as low as 6.73% and range as high as 35.36%. LendingClub says its rates start at 6.78% for loans that range from $1,000 to $35,000 for terms as long as three years while Upstart rates begin at 6% for sums that range from $5,000 to $25,000.

All promise “no hidden fees,” “no prepayment penalties” and “no rate hike or payment increases.”

Upstart assures potential borrowers, “Won’t affect your credit score!” LendingClub promises, “Won’t impact your credit score!”

The loans are marketed to young adults, advertising that funds they borrow can be used to repay student loans or pay for graduate school and consolidate credit-card debt. “Peer-to-peer’s rapid growth,” Demyanyk and Kolliner find, can be attributed in part to the companies improving the access to credit of people with short credit histories, especially young people.

Most banks are unwilling to lend to applicants with short credit histories -- that is, less than three years -- even when they have high credit scores, the Cleveland Fed researchers write. Demyanyk and Kolliner note that Equifax, one of the three largest credit bureaus in the United States, report that just under 40% of people with short credit histories have credit scores above the subprime threshold, that is, they would otherwise qualify for a loan.

Peer-to-peer lenders allow their borrowers to consolidate their credit-card debt and at lower rates than most traditional lenders. Since the first quarter of 2010, Demyanyk and Kolliner write, the interest rates on peer-to-peer loans have been lower on average than those charged by credit cards.

Five in six peer-to-peer loans are personal one-time loans, most of which the borrowers use to consolidate their credit-card debt. 

Upstart also promotes peer-to-peer loans as a way to fund the startup of a business.

The websites of all three make it easy to apply online.

Peer-to-peer lenders want to know the applicant’s income, type of employment and credit scores to assess their creditworthiness. They’ll even consider an applicant’s SAT score as a factor, the Cleveland Fed researchers found, if a lender thinks it’s relevant.

Mostly though, peer-to-peer lenders want top-grade borrowers who pose less risk of default, those they give grades of “A” or “B.” Such borrowers have been charged interest rates of just above 8% to 10.5% on average between 2007 and mid 2013 compared to credit-card rates that have averaged just below 12% to 15.5% in the same period, and just below 14% to a shade below 18% for those graded “C” or “D” by peer-to-peer lenders. This says that not all peer-to-peer loans have lower rates than bank or credit-card loans.

Between the second quarter of 2010 and the first quarter of this year, 3.2% of peer-to-peer loans were past due compared to 3.7% of standard consumer finance loans. And over this period, peer-to-peer loans had a lower share of poorly performing loans in 10 of the 16 quarters, Demyanyk and Kolliner write.

Copyright 2014 The Business Journal, Youngstown, Ohio.
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