Lending Club, which is challenging banks by helping investors lend money directly to individuals, made headlines recently by filing to go public. The lender, which received financial backing from Google last year, has facilitated more than $5 billion in loans since its launch in 2007, according to its investor prospectus, with $1 billion of that coming in the second quarter of 2014 alone.
It's not just Lending Club that's rolling in, and dolling out, dough. Peer-to-peer, or P2P, lending of this sort is a booming business. In 2013 Lending Club, together with Prosper Marketplace, the country's other big P2P lender, issued $2.4 billion in loans, versus $871 million in 2012. In the context of that rapid growth, a successful Lending Club IPO would be a “key milestone” in the growth of the peer-to-peer lending industry, the credit analysts at Fitch Ratings said Thursday.
Why has P2P lending taken off, and how exactly does it work?
It’s a new business model that wouldn't be possible without the Internet and the kind of sophisticated software code we now take for granted.
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P2P lenders act as online meeting places between individuals who need to borrow money and people who have money to lend. In the case of Lending Club, would-be borrowers with a credit score of at least 660 apply online for a loan of up to $35,000. They go from application to loan disbursement without ever talking to a human being. The company screens applicants using an algorithm that checks their credit histories and other relevant data points, and then presents them with loan offers — if they qualify. Lending Club says less than 10 percent of loan applications are approved. It takes a 1 percent cut, on top of charging some fees.
Why bother going the P2P route if there are these trusted institutions called banks around? For one thing, banks aren't actually that trusted, or even liked, anymore. The financial crash, subsequent bailouts, and the banks' increasingly apparent bad behavior leading up to the crash took care of that. As such, some people are more than happy to consider financing alternatives.
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Banks can’t serve all borrowers anyway. Credit is still tight since the financial crash, banks are being asked to hold more capital in reserve now in case of financial emergency. Banks are also not big on loaning the small amounts many P2P users are looking to borrow; there's not enough profit in it.
P2P lending gives borrowers with credit scores that don't pass traditional bank muster a better shot at getting a loan, even if it means paying a somewhat higher interest rate. Though rates for Lending Club loans can start below 7 percent and go as high as 26 percent, the average rate is around 14 percent — quite high compared to, say, a 30-year mortgage at just over 4 percent but still likely to be better than what borrowers would get from a credit card.
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For investors, P2P lending offers the chance to generate serious return on their money at a time when banks are paying next to nothing and bonds yields are still low. Of course, it's not necessarily that simple: That hypothetical return comes with risk. Peer-to-peer lenders aren't banks. As such, P2P investors don't get the inherent safety they would if they simply deposited their money in a bank account. “The Notes are highly risky and speculative as you do not know the borrower members and are investing based on limited information that may be unverified or inaccurate,” a Lending Club prospectus warns.
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Still, in a free-market economy, sometimes there's nothing that feels so good, or is as profitable, as cutting out the middleman, especially when the middleman you're cutting out is a bank — an age-old business model just begging for a little 21st century disruption.
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