Question: Hi Chris - I was listening to the marketplace money podcast (6/10/2011) and one of the guests mentioned peer-to-peer lending. I googled the topic and found several websites dealing with this issue. This looks really appealing since I have extra cash sitting in the 0.25% saving account. But on the flip side, it looks really too good to be true. What could be the problems for peer-to-peer lending? And is there any reputable website for peer-to-peer lending? Brit, Norwalk, CA

Answer: Peer-to-peer lending (also called social lending) is among the more intriguing personal finance innovations of recent years. The business started 5 years ago and peer-to-peer websites bring together online individual lenders and individual borrowers for a fee. Think combining Match.com and Ebay.com. A website for learning about the business and keeping up on industry experience is Sociallending.

The two main companies are Prosper Marketplace Inc. and the Lending Club Corp. The bread and butter business of peer-to-peer lending has been living off high interest credit card debt.

Let's say you're paying 18% to 21% on your credit in a low rate environment. The peer-to-peer lending companies figured there would be individuals willing to lend money at, say, 9% to 12% for someone eager to shed the high rate credit card debt. When it works it's a win-win deal.

The peer-to-peer companies have recently been filling in another niche: Matching small-business owners and individual lenders. The Wall Street Journal has an overview of the trend:

The returns on these loans vary, depending on the length of the loan, its interest rate and, perhaps most importantly, the borrowers credit quality. It's hardly surprising that the default rate of less creditworthy borrowers is higher than their creditworthy peers. There is no free lunch.

My sense is that there are two kinds of lenders in this market. Some people dabble in it, curious about how it works, hoping that they'll make a higher rate of interest on their money. Others seem to turn it into much more of a portfolio strategy and spend far more time deciding where to lend and how much. If you're intrigued I would stay cautious. Put a little money at risk and see how you like it.

I would not put your emergency savings at risk.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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