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Peer-to-peer lending, also referred to as social lending, person-to-person lending, microfinance and microloans, is a nontraditional form of lending involving unsecured loans between individuals. This is in contrast with traditional lending, where a bank or other financial institution makes loans to individuals.

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The low volume of education loans at peer-to-peer lending sites is partly due to the short-term nature of peer-to-peer loans, which typically require short repayment terms ranging from 1 to 3 years. Traditional student loans have a longer-term horizon of 10 to 30 years as well as other terms customized to the need of students, such as in-school deferment of repayment. This has lead to the development of peer-to-peer lending sites that focus on education loans, such as GreenNote.

Peer-to-peer lending sites may offer one or more of the following services:

• Documentation of loans. This includes paperwork, such as fully executed promissory notes.
• Servicing of the loans. This includes collection of payments and reporting the payments (or delinquencies) to credit reporting agencies.
• Matching borrowers with investors.

Peer-to-peer lending sites typically fall into two main types:

• Friends & Family. These sites provide formalized documentation of a loan (e.g., a properly executed promissory note) for a fixed fee. They may also provide servicing (collection of monthly payments) for a percentage of the outstanding balance. The interest rates on these loans are usually lower, sometimes competitive with the interest rates on government education loans.
• Stranger-to-Stranger. Also known as person-to-person loans, these sites match lenders with unrelated borrowers. Not only do they document the loans, but they also service the loans and sometimes provide a guarantee against default. Usually these sites have minimum credit criteria. The interest rates are usually higher, sometimes competitive with the interest rates on private student loans.

Advice for Borrowers

Borrowers should focus on federal first, as federal education loans are cheaper, more available and have better repayment terms. Peer-to-peer lending should only be considered as an alternative to private student loans, and also more expensive forms of credit such as credit cards.

Potential advantages of peer-to-peer lending over private student loans include:

• Avoid the need for a cosigner.
• More personal in that the borrower often gets to make a personal argument for why he or she deserves a loan.
• Lower credit scores.
• Fixed rates.
• More flexible. An education loan from a peer-to-peer lending site may allow you to spend the money on more than just the college's cost of attendance. The money goes directly to the student, not the school.

It is important to recognize that a peer-to-peer loan might not get fully funded, or funded at all. Except at friends and family sites, where the lender has a vested interest in the success of the borrower, the lenders are focused on obtaining a reasonable return on their investment. If the borrower asks for too low an interest rate or too much money, they might not attract any lenders.

Some of the peer-to-peer lending sites let the borrowers provide some background on why they need the money. Often this information is structured, providing information about the degree program, year in school, name of the college and GPA. In some cases the borrowers can post a message to the prospective lenders to tell them how they will use the money, and may include a photograph and recommendations from friends.

Peer-to-Peer Lending Sites

• GreenNote
• Lending Club
• Prosper Marketplace
• Zopa USA

Other Resources

The Peer-to-Peer Lending Calculator helps lenders evaluate the impact of the risk of default on the returns on investment. Given some details about the loan and the risk of default, it calculates a risk-free rate of return.

See also Loan Comparison Sites, which are sites that compare the terms of traditional federal and private student loans.

If you’re considering lending to students to help them pursue their higher education, consider Advice for Peer-to-Peer Education Lenders.