Financial crisis spells business for lending sites

One woman wants to pay off medical bills. An Ohio couple wants $5,000 to start a home business. An Illinois college student needs help with tuition.

With bank loans drying up amid financial turmoil around the world, these would-be borrowers aren't looking to traditional channels for money. They have turned to the fast-growing online industry of peer-to-peer lending, in which online companies like Lending Club, Prosper and Loanio connect people who need money with those who have it.

Through this peer-to-peer arrangement, borrowers get the money they want, typically at lower rates than through a credit card or bank, while individuals lending the money collect higher interest rate returns than they might find in more traditional investments.

Twelve traditional banks turned down Tim Murphy's request for a $25,000 loan to start a gourmet popcorn shop in an Atlanta suburb, but he found 97 different individuals willing to share in lending him the full amount through Lending Club.

Murphy's 1,600-square-foot store now offers a dozen varieties of popcorn, including parmesean and garlic, ranch-flavored and nacho cheese. "It's growing, slowly, but growing, said Murphy.

While demand for peer-to-peer loans is on the increase as traditional banks tighten their lending, the model is not without its problems.

Prosper earlier this month stopped signing up new lenders while the Securities and Exchange Commission evaluates its regulatory filings, a process that could take up to six months.

The amount of new lending on Prosper each month was already declining from a peak in May and average interest rates were increasing.

With the U.S. economy sliding toward recession, lenders are becoming leery of tying their money up in a peer-to-peer loan that typically runs three years and borrowers who could default.

Nevertheless, the model is still enticing for some investors and the peer-to-peer sites say they are here to stay.

Eric Di Benedetto of San Francisco said he and a partner have loaned nearly $1 million to hundreds of borrowers, and so far have found much better returns - averaging above 12 percent - than they could have garnered elsewhere.

"The stock market hasn't really done well over the last few years," said 43-year-old Di Benedetto. "We were looking for something that was relatively safe while returning double-digit returns.

And a new company, Loanio, entered the market on Oct. 1, aiming at borrowers who have been turned away from other lending sites because of poor credit.

More than 1,000 people signed up to participate within Loanio's first week, according to CEO Michael Solomon. The company encourages borrowers to use friends and family as co-signers and verifies a borrower's financial footing for a fee, Solomon said.

REUTERS