With all the dismal talk surrounding the economy and the subsequent belt-tightening of the lending industry, peer-to-peer, or P2P, lending has been a warm ray of light and hope. It is the natural outgrowth of an increasing demand for financial assistance coupled with the versatility and social reality of the Internet. Through peer-to-peer lending, consumers and small businesses can access loans from other people on the Internet while avoiding banks or credit cards.

How It All Started

As the credit bubble started bursting, banks and lending institutions began tightening the requirements needed to secure financing. This left numerous individuals and small businesses scrambling for alternative means of funding. When faced with such a situation, many people instinctively turn to their family members, friends, and neighbors. While this may provide a quick funding solution, it lacks the formality and security that traditional lending offers.

But the future looks bleak for those seeking traditional financing. It is well known that the decrease in Federal interest rates will not necessarily filter down to the consumer.

How Peer-to-Peer Lending Works

Enter the vast social networking world of the Internet. Numerous sites have been recently launched that create a marketplace for borrowers and lenders to find each other. Even among friends and family, everything is carried out formally and professionally. These sites provide identification and verification services as well as an assessment of the credit risks. Clear, precise documentation covers the loan’s terms and conditions as well as the repayment schedule and tax payments as determined by both parties

Though there is some variation among the different sites, they all basically operate the same way. Borrowers post their loans including any information necessary for a lender to consider the request. Included in the post is the amount requested and the maximum amount of interest they are willing to pay. One unique aspect to peer-to-peer lending is that it gives people the chance to tell their story.

Some sites open the loan request up to many people at a time- both acquaintances and strangers. The loan is then set in small increments which allows several different lenders to fund portions of the total amount and thus spread out their risk.

Once funding has been completed, many peer-to-peer lending institutions continue to provide loan administration throughout the duration of the loan. This includes monitoring repayment. If 30 days go by without a payment, the loan is immediately sent to a collection agency.

The Major Players

Currently, the largest peer-to-peer lending website is Virgin Money. Virgin focuses primarily on lending among family and friends and promotes their formalized process.

The next largest site is Prosper.com which, like Virgin, encourages friends and family to lend to each other, but they also open their market up to strangers.

Another service, Lendingclub.com, requires a business profile and uses a search algorithm that matches prospective lenders and borrowers.

Other popular sites include: Zopa.com, GlobeFunder.com, and Community Lend.

Some Drawbacks

Like every good thing, peer-to-peer lending does have its drawbacks. Most sites put a cap on the amount that can be funded- usually around $25,000. So those seeking larger amounts will need to look elsewhere. Moreover, like any other traditional loan, defaulting on payments will tarnish a credit rating and thus prevent future financing. Finally, even with the formalized process, the general rule is that money and relationships don’t always mix so nicely- especially if payments are not met.

The bottom line, however, is that peer-to-peer lending is here to stay as a quick source of financing and a ray of hope for those who need.