Peer-to-Peer Lending As an Investor
NEW YORK ( MainStreet) The "Aha!" moment came for Simon Cunningham in 2011, not long after he landed his first real job and was looking for a way to start socking money away for retirement. Proficient in technology, literate in financial matters and committed to social responsibility, Cunningham was hooked the moment he came across an article about a new way to loan money called peer-to-peer lending.
The article described a quickly emerging industry that used online platforms to match individual borrowers with private lenders. People with less than stellar credit were able to obtain loans, usually at lower than standard rates. Those with money to invest were able to help people in need and realize returns often higher than they could get elsewhere.
It was a win-win, says Cunningham, who began investing almost immediately through the two primary P2P lending sites and now edits a blog called LendingMemo.com that advocates for the practice and helps others navigate its intricacies.
In the two years since he became involved, P2P lending has exploded. The largest player, Lending Club, crossed $1 billion in issued loans last November after five years in operation and hit $2 billion just eight months later. Shortly after, it attracted a $125 million investment from Google. Its rival, Prosper, has issued only about one-third as much but reports volume growth of 10% monthly. It also just picked up new venture funding and boasts of a board that includes former U.S. Treasury Secretary Lawrence Summers.
What's this mean to investors? "I've been one for more than a year," says Kimberly Foss, founder of Empyrion Wealth Management and author of the new book Wealthy by Design (Greenleaf, 2013). "This is the epitome of the free market. I'm a big fan."
A boom in less than a decade
The concept took root in 2001 when a startup called Circle Lending was formed to facilitate loans between relatives and friends. Prosper launched in 2005, pitching the idea that unconnected individuals credit-challenged borrowers and investors with money to lend could be brought together online. Lending Club followed two years later and now has 85% of the market. (A few other companies like National Family Mortgage, which formalizes home mortgages between friends and family members, and Common Bond, which specializes in student loans, serve other niche sectors.)
Getting underway just as the Great Recession was gaining steam, however, the industry initially struggled as a number of early borrowers defaulted. This caught the eye of the U.S. Securities and Exchange Commission, which determined that the loan notes being funded were in fact securities and initiated oversight in 2009. Fine-tuned underwriting and tighter controls followed, as did increased liquidity from the secondary market that developed for buying and selling these SEC-regulated notes. And while some risk definitely remains, the stability has steadily improved and continued to win over investors like Cunningham and Foss.