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How to bypass the bank and get a loan

Websites are allowing person-to-person loans, cutting out the middleman.

By Simone BaribeauContributor to The Christian Science Monitor / April 30, 2007



New York

A man dressed as the animated movie hero Mr. Incredible presents himself before a group of lenders. He wants a new gaming system, new wakeboard bindings, and maybe a vacation. Or, as he puts it, "$6,000 to blow for fun." And he's willing to pay 10 percent annual interest for a three-year loan.

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Conservative financial institutions might have found his outfit off-putting, but members of the social lending website Prosper seemed to appreciate the borrower's photograph and AA credit rating posted on the site. Over the course of a week, 180 lenders offer to buy small chunks of the loan, bidding the interest rate down to 8.99 percent. By the time the online auction ended, almost 90 lenders had divvied up the loan.

"I think a bit of emotion kicked in with Mr. Incredible. [He was] kind of like an alter ego," says Mike Beer, an airline pilot who lent $50 toward the $6,000 loan. "It was like, 'you go,' because I could never borrow money to buy toys. Not my thing."

Prosper, open to the general public since February 2006, is the United States' first – and only – online marketplace where anyone with $50 can receive interest on money they lend. Although the market is small – the website only recently surpassed $56 million in loans – opportunities for people interested in investing in personal debt are growing. Over the past six months, the amount of money Prosper members lent out almost doubled from the previous six months.

Social lending removes the middleman, allowing both lenders and borrowers to get better rates, contends Chris Larsen, CEO and cofounder of San Francisco-based Prosper. "A bank is coming to you and saying, 'I'll take your money – it's worth 4 percent' and literally lending it out at 19 percent," he says. Instead, he suggests that maybe you and your neighbor could come to an agreement on a loan at 12 percent.

Prosper makes its money by charging its members fees on loans, which range from 0.5 to 1 percent for lenders and 1 to 2 percent for borrowers, depending on the credit grade of the borrower. Mr. Larsen estimates that borrowers can get rates 3 to 5 percent lower on Prosper than they would with a credit card.

The estimated average annual return on loans to borrowers with AA to D credit scores ranges from about 6.0 to 8.5 percent, according to the company. Returns for loans to borrowers with E and HR (high-risk) rated credit scores are negative, though Prosper has recently strengthened its requirements, mandating that borrowers have a credit score of at least 520 to be eligible to apply for a loan.

Some lenders use other criteria to improve their rates of return. Kurt Dickey, a North Carolina technology product specialist has lent almost $40,000 on over more than 240 loans. He has a standing that allows him to automatically bid on loans when preset criteria – including credit grade, home-ownership status, repayment method, past defaults, membership in community groups, debt-to-income ratio, and interest rates – are met.

"I tweak it," says Mr. Dickey. "When I do have time and I have money, I go on there and troll around and find loans that I have an interest in."

Dickey's investing efforts are paying off. He says that according to his lender's statements, his rate of return is 13.6 percent.

How to improve credit

To determine the credit worthiness of potential borrowers, the social lending website Prosper relies on a scoring system provided by Experian, a major credit reporting agency in Costa Mesa, Calif. Experian's credit scores are used to "grade" borrowers from AA (topgrade) to HR (high risk) and help lenders assess whether it's worth loaning them money. (You can obtain your credit report – one free report per year – at Experian.com.)

Prosper grade: Experian score

AA: 760 and above
A: 720-759
B: 680-719
C: 640-679
D: 600-639
E: 560-599
HR: 520-559

To improve your credit score, pay bills before they're more than 30 days overdue, avoid extra credit-card applications, and keep credit-card debt under 40 percent of available credit, says Gary Thurberg, at Consumer Credit Counseling Services of Central New York. Establishing a credit history (which includes secured debt such as a mortgage or auto loan, and unsecured debt such as a credit card), matters, too: You may pay your utility bills, cellphone, and rent on time, but typically payments aren't reported to a credit agency unless the bills are sent to collection, he says.

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