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Can Peer-To-Peer Finance Work?
Dotnaught writes "Two companies, Prosper and Zopa, appear to be convinced that social networking can be combined with borrowing and lending. They're intent on using eBay as a model for listing and bidding on loans without the involvement of a bank. Call it peer-to-peer finance. There are already some 800 groups on Prosper ready to loan money to specific causes, such as the Apple User Group, 'a lending group for those wishing to purchase either a Macintosh or Apple iPod.'"
These businesses may be entering a market that's already full of competition but I think the main idea is that regular people can loan small amounts of money, together effectively becoming as large a business as the existing businesses -- although the profits may be smaller, people aren't doing it for a living. Each person is giving a little, but they can effectively compete with large companies. (And losing $100 or so won't hurt the types of people who will invest money into P2P loans).
Although it might not be as large a benefit to investors, it could increase competition in an already competitive market and help borrowers to secure better loan terms. Hopefully, this could also help out people with poor credit ratings as there are more potential businesses to loan them money.
Two obvious examples are
And it's hard to underestimate the stupidity of some lenders. I imagine there are plenty of people with a lot of money who will seriously consider lending to a high-school kid to get an XBox in the same way that they consider lending to former Nigerian Royalty to help them get millions out of there.
Hmm...
Speaking as someone who is committing money to a community bank with roughly $2,000 in it, I think the thing is that people trust their own culture, and are more willing to accept risks and lend money within their own culture. People tell each other things amongst themselves, that they do not necessarily tell the banks.
If you lose, it was "for the cause," anyways. If you win, you've aided the cause.
The bank might not even be willing to talk with you.
I know a girl, she's going to college. She needs $50,000 for 4 years of loans. The banks aren't talking with her, and her parents are opposed to her going to college out-of-state. (Read: The parents want to keep her near, to better control her.)
If my culture were just a wee bit more organized, I'm sure we'd have her in her preferred college. (UCSD, I believe.) As it is, we only have $2,000 amongst ourselves.
If only she were going to college in 4 years...
You may also want to check out the concept of Internet Bonding. Basically, if you can look at all the things a person does online, says online, follow the ups & downs in their life, and so on: You can do interesting things with that. You can better evaluate risk. So, if you're operating within your culture, things get a lot easier on you.
In the case of this girl, she has an easy time explaining to us who she is, where she's coming from, and so on: You can see her last few years of work online. "Trustworthy!" we say, "Get that woman her CS degree!"
Hey, why lend when you can give?
Global Giving is the charitable expression of the same idea. Instead of giving at the office to some anonymous organization, why not fund: Renewable Energy to 20 Peruvian Communities, Improving Computer Literacy in Afghanistan, Information Technology for Uganda Medical Students, or whatever else floats your boat.
So I assume you never invest in stocks or corporate bonds then, because they have risk and you don't know the people you're giving money to?
There is a clear risk/reward relationship here. The highest 3 year CD rate I can find is 5.4% APY. I have $1000 into Prosper at an average rate of 16%. That is far higher than any bank or CD rate (because the risk is greater). Is it a good investment? Depends on whether or not all my loans get paid back in full. At $50 a loan I can afford for a couple to default and still come out ahead of the CD option (once I've scaled to a large enough number of loans).
Additionally, I get monthly cash flow (albeit not a lot of money on $1000 investment). I can either reinvest it or take the cash. Should I need the cash immediately (which I doubt, I have other, more liquid reserves for that) I could always take out a loan (on Prosper) at a lower interest rate than my average (because I have good credit). The loan could then be paid off from the proceeds of loans I've made.
In truth, the larger risk of Prosper is in the amount of time needed to discover and research new loans on a regular basis.
I've written up a longer post on my experience with Prosper on my personal finance blog.