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Have you never borrowed money? If so, you're the member of a very tiny minority. Almost everyone borrows money at one time or another. Maybe it’s to finance a car or to pay off a medical bill. You may not think of it this way but if you have a credit card you've borrowed money – even if it's only for a couple of weeks. And, of course, if you have a mortgage you’ve borrowed a lot of money.
Personal loans, credit cards, mortgages and personal lines of credit are the traditional ways to borrow money and have one thing in common – there is a bank involved.
A simple business
Actually banking is a fairly simple business. Banks take in money in the form of savings accounts, money market accounts or CDs (certificate of deposit) on which they pay a very minimal interest rate and then lend it out at a much higher interest rate. The difference between the two is to cover the banks' overhead or cost of doing business and to generate a profit. The banking business is a very profitable one right now because they're paying 1% or less on savings accounts and CDs and then lending the money at 9%, 12% or even higher.
What the banks don't want you to know
What the banks would rather you not know is that there is a new way to get a personal loan that totally takes them out of the equation. It's called peer-to-peer or marketplace lending and it’s the hottest thing in lending today because it can offer loans at much lower interest rates than can banks.
How it works
Have you ever borrowed money from a friend or a family member? That was peer-to-peer lending because you got the money directly from a person with no bank standing between the two of you as a middleman. While this has been going on ever since Grok borrowed two drachmas from his friend Zork, it’s now morphed into something entirely different thanks to the Internet. In fact there are now more than a dozen websites offering marketplace loans and more seem to spring up almost monthly.
Morphed from peer-to-peer to marketplace
This type of lending was initially called peer-to-peer loans because they were loans to a person from a person or group of people. The way it worked is that a person would go to a website such as the Lending Club or Prosper and fill out an application. Prospective lenders review the application and if they like what they see they would then offer to fund the loan. The lenders were able to offer loans at a much lower interest rate than could a bank because they’ve taken away the banker’s commission and replaced it with the much lower commission charged by the website for handling the transaction. In addition, the lenders on these websites have practically no overhead. Everything is done via computers. Once a loan is approved the funds are direct deposited to the borrower's checking or savings account and the loan is repaid through automatic withdrawals. The term of these loans is typically either three or five years.
If you have bad credit
Another thing that makes marketplace loans different from bank loans is that you should be able to get one even if you have bad credit. Banks tend to be very risk adverse or as the old joke goes, they only want to loan money to people that don't need it. On the other hand marketplace lenders are more likely to take a risk on a person with bad credit if she or he writes a very good "pitch" or how they would use the money. Of course, as with a bank, the more risk you represent the higher your interest rate will be.
The big guys moved in
Peer-to-peer lending proved to be such a good idea that money has moved in from financial institutions such as large hedge funds, which necessitated the change from peer-to-peer lending to marketplace lending. In fact, Forbes magazine has reported that 80% to 90% of the money being distributed today by sites such as Lending Club and Prosper comes from institutional lenders.
It doesn't make much difference
It actually doesn't make much difference whether the money you borrow is from a person or a hedge fund. The application process on most of these sites is simple and requires just a few minutes to complete. You can actually receive an instant decision as to the amount of money that's been approved and what your interest rate will be. But you will probably then need to submit documentation such as your W-2 forms to confirm your income. The point is that the loan will come with a lower interest rate than from a bank because there is no middleman involved. And of course, this is why banks hate the idea of marketplace lending.
The interest rates
What kind of an interest rate could you get with a marketplace loan? Here's where this form of lending is not much different from that of a bank. It will depend on the amount of risk you represent. As an example of this Prosper is currently offering loans at interest rates from 6.73% to 35.36%. Lending Club has loans with interest rates from 6.78% to 29.99%. And Upstart is currently offering loans with interest rates as low as 5.75%.
Even businesses can get a marketplace loan
If you have a small business and need money to expand there are marketplace websites that specialize in lending money to businesses. Two of the biggest of these are Kabbage and Lending Circle, which is currently offering loans up to $500,000 with interest rates as low as 5.99%.
It’s called disintermediation
What this new form of lending is doing to banks is the same as what sites like Uber and Lyft are doing to the taxicab industry. It's called disintermediation and what it does is eliminate the middleman In addition, the marketplace sites make it much easier and more convenient to get a loan versus having to go to a bank and beg for the money. Banks may turn you down for a loan because they see you as a high-risk borrower. But it’s very probable that you could get the money from a marketplace lender although it will, of course, come at a fairly high interest rate.
It's like banking once was
Banking used to be a fairly simple business. Then Congress got in to it and the business is now ruled by regulations. In comparison, marketplace lending has no regulations – again because there is no financial institution involved. Loans are simple transactions between a borrower and a lender. However, federal agencies such as the Consumer Financial Protection Bureau must be gnashing their teeth because at least at this time they can't regulate marketplace lending. You know they must be lying awake nights trying to figure out ways to change this because, well, regulators want to regulate.
But is it for you?
If you're wondering whether marketplace lending is for you here's a short video, courtesy of National Debt Relief, that could help answer this question.