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Peer-to-peer lending can save you money

May 10, 2010 12:00:00 AM PDT
If you're looking to borrow money to pay off bills or buy a new vehicle, you don't have to apply for a loan at a bank or credit union. Many people are asking and getting loans from strangers, and saving a ton of money.Peer-to-peer lending brings borrowers and investors together. Borrowers can find a lower interest rate than the banks offer, while investors get a far better return than certificates of deposit.

You can even invest in a retirement account and earn a return of 10 percent or more.

Mary Bohen of Redlands racked up about $27,000 in credit card debt. The single mother of two struggled to pay it off, even moving to a smaller place. But with interest rates as high as 24 percent on some of her credit cards, she struggled to make ends meet.

Mary turned to the Web site LendingClub.com in search of a better rate. She posted her profile online and listed information about her salary, job history and credit score. More than 400 investors liked what they saw and funded her $20,000 loan.

At an interest rate of 13 percent - which is about half of what she was paying - she's saving thousands of dollars in interest over the life of the three year loan.

"I was able to take that money and I was able to pay off my credit cards with it," said Boehn. "My credit score jumped up like 50 points."

Late last year, Tom Youngen wanted to diversify his investment portfolio. The San Diego resident grew frustrated earning one-percent on his bank CD, so he decided to become a peer-to-peer lender. He's funded some 200 loans in a ROTH IRA account, never lending out more than $100 to any one borrower. So far, he's been earning close to a10-percent return on his investment.

But since these loans are unsecured, he's taking on some risk.

"I fully expect some of these loans will default over time, and if they do default, then I'm back to 6-to-8 percent," said Youngen. "I'm still above where I'd be with a CD."

Sites like LendingClub.com and Prosper.com rate loans on how likely a borrower will pay them off, using criteria like credit and employment history. The lower the credit score the riskier the loan, which leads to higher interest rates.

Lenders can set up filters to search out more secure investments, but if a borrower defaults, they could lose their money. That's why lenders are encouraged to lend only small amounts to each borrower.

"We always encourage investors to diversify across as many loans as possible," said Renauld Laplance, CEO LendingClub.com. "Lending money to one person is a risky bet. That person may not pay you back and then you've lost your entire principal."

There's a limit of $25,000 you can borrow on the peer-to-peer lending sites. If you're a lender, remember the loans are not secured, so there are risks involved. But since interest rates are usually much lower than banks or credit cards, both borrowers and lenders can benefit.