What is Social Lending?
Social Lending (also known as Peer-to-Peer Lending) are online communities connecting people so they can loan and borrow money from each other thus eliminating the middle man, the bank. Because the bank is eliminated, lenders and borrowers can lend and borrow money at better interest rates for both parties with extremely low fees. The current major players are Lending Club and Prosper.
Both Lending Club and Prosper are very similar except that Prosper uses an eBay auction style where the interest rates are set by lenders via a bidding process. Lending Club sets the interest rate based on a formula and lenders and borrowers have to accept the rate. There is no bidding.
A borrower at Prosper offers a maximum interest rate; however, the interest rate can be reduced if enough lenders bid on the same loan. Lenders who bid on a loan must offer the lowest interest rate they are willing to accept. The offered interest rate is not disclosed to the borrower or other lenders. As more lenders bid on the loan, the interest rate will be reduced.
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Lending Club sets interest rates for the borrower and lender based on the borrower’s credit score and other financial parameters. A loan grade is then established which takes into consideration Assumed Default Rate, Lending Club Base Rate, and Adjustment for Risk and Volatility.
Unlike a bank, when you invest in loans, your money is not FDIC insured. Only when your money is in cash in your account is it FDIC insured by both Lending Club and Prosper. Keep in mind this is investing and not a savings account. There are risks involved. The main risk is for lenders having borrowers who default on their loan.
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