In the traditional scheme of things, lending institutions offered funds for average people seeking home loans. Today, however, a new school of mortgage origination is gaining popularity. In this go-round, the lending institutions play no role whatsoever. Instead, the average people are both the borrowers and the lenders.
It's called peer-to-peer lending (or P2P for the acronym-minded). As a lending sector, it is still in a relatively nascent state with only a handful of players. However, P2P lending has already generated a fairly significant amount of activity in a relatively short period of time – and one leader in this young field has already been acquired by a major global investor.
P2P lending utilizes the Internet to connect private investors with people in need of small loans. Sometimes the borrowers and lenders know each other, sometimes they are complete strangers who connect via online forums.
CircleLending, a Boston-based company that facilitates loans between friends and families, was launched in 2001. The company, which has facilitated over $200 million in loans, prefers to use the term "inter-family" lending rather than P2P, since it is not involved in transactions between strangers.
San Francisco-based Prosper, launched in 2006, offers a setup similar to the online auction site eBay: Individuals list and bid on loans. Prosper requires those listing their lending requests to post their debt-to-income ratio and other credit report-related data for potential investors to review. To date, Prosper's members have generated more than $65 million in loans.
Other players in the P2P realm include LendingClub.com, an offshoot of the popular Facebook social networking site, and Zopa.com, a British entity that has yet to expand into the American market. The research firm Online Banking Report estimates $100 million in P2P loans will be transacted during this year, and the volume could increase to $1 billion in three years.
At the moment, the direct residential lending aspect of P2P activity is low. "I would say six to seven percent of folks have listings specifically to real estate," says Chris Larsen, chief executive officer for Prosper.
But Larsen points out that many Prosper lending requests would've been filled in the past through home equity lines of credit. "In the past, real estate [through home equity loans] was a cost-effective way of funding purchases, vacations and so forth," he adds. "But conditions have changed drastically."
Asheesh Advani, founder and president of CircleLending, cites that P2P is being presented as an alternative vehicle for those considering reverse mortgages as a source of income. "There is a downside to reverse mortgages: You lose your home to the bank!" he says. "If you can keep it in the family unit, that's a pretty good thing to do."
For Advani, the inter-family aspect of P2P is crucial to its success. "We're about keeping the wealth in the family rather than in a piggyback lender," he says.
To date, P2P lending has avoided the catastrophic aftereffects of subprime lending. "The vast majority of our clients are prime, not subprime," continues Advani. "They have wealthy relatives helping them buy a home or upgrade from a condo to a home, and they are trying to avoid private mortgage insurance or paying seven to nine percent on piggyback loans. With subprime borrowers, a much smaller percentage have wealthy relatives."
Prosper's Larsen notes that all levels of borrowers participate on his site, but the A-paper customer is most desired by individual investors. "We see more prime and near-prime loans get funded," he says. "As it is playing out now, nearly 95 percent of loans are in those categories, while the subprime percentage is decreasing."
But that's not to say P2P is free of problems. P2P loans are unsecured, and it's incumbent upon the individual lenders, not the P2P facilitators, to deal with late payments or delinquencies. For Prosper, one way to ensure creditworthiness is by requiring borrowers to have minimum credit scores of 520 (the service originally did not require this).
This spring, the P2P sector caught the eye and wallets of investors. In May, Virgin USA, Sir Richard Branson's North American investment group, acquired a majority stake in CircleLending. In June, Prosper closed on a $20 million Series C financing round led by a group of venture capital investors.
What's next for the P2P companies? Answer: the secondary market. Advani confirmed that CircleLending will be heading in that direction, but he was unable to provide specifics or a timetable. "It's too early for us to talk about it," he says.
Prosper's Larson is also eyeing the secondary market for the near future. "We are working on that as our number-one feature set," he says. "We're confident we'll have that before too long."