Peer Lenders: A Last Resort for Student Loans

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Peer Lenders: A Last Resort for Student Loans

WIDESPREAD CUTBACKS among lenders have some students relying on the kindness of strangers to help them pay for college.
Thanks to the credit crunch, dozens of student loan lenders, including the nation's largest, Sallie Mae (SLM: 9.42, -0.50, -5.04%), have either dramatically cut back on their offerings or have stopped offering loans altogether. As a result, a growing number of students are turning to peer-to-peer lending sites like Prosper.com and LendingClub.com that facilitate loans between strangers, allowing a cash-strapped consumer to find a willing lender to loan them money.


The attraction for borrowers: Interest rates can sometimes beat out those offered by private student loan companies, and there are usually fewer fees and restrictions. For lenders, it's a way to simultaneously earn a decent rate of return on their cash and help someone in need. "It's an interesting concept, the idea of investing in an individual student," says FinAid.org publisher Mark Kantrowitz, who is considering adding a peer-to-peer lending page to his financial aid information site.

The growing interest in peer-to-peer student loans has even given rise to two web sites focused solely on education debt: Fynanz.com and CollegeDegreeFund.com. Social finance site Zopa.com plans to launch a student loan feature in July (right now, student borrowers apply for a personal loan). At this point, however, students are still a minor market for social lending, which is typically used for loans to pay down debt or launch a home business. At Prosper.com, for example, education loans account for less than 2% of its $135 million in loans.

But before turning to a peer-to-peer lender, students should exhaust all other funding options first. "[These sites] are not set up to be student lenders," says Lawrence Glazer, a managing partner at Boston-based investment firm Mayflower Advisors. "There are still more than enough private lender players out there to get people the money they need for college," says John Pearson, a CPA and certified college planning specialist based in Norwalk, Conn.

Even the sites themselves admit that they're not the first place borrowers should turn to. "Federal loans are still the way to go," says Prosper CEO Chris Larson. Fynanz won't even accept applications from borrowers who haven't first tried to get loans by filing a Free Application for Federal Student Aid.

Here are four things to consider before you seek tuition money on a peer-to-peer lending site:

Eligibility
Students will have to meet certain criteria in order to list their loan request on a site, says Kantrowitz. They may need a co-signer, or simply have Mom and Dad apply instead. Young borrowers tend to have credit scores on the lower end of the 300- to 850-point scale, because of short credit histories and outstanding credit-card debt. That could result in a less-favorable risk profile from the site, or outright rejection. Still, borrowers may have a better shot with social lending sites than they do with private lenders, which usually require a credit score of more than 650. In comparison, LendingClub and Zopa both require a score of at least 640. Prosper's cutoff is a much more forgiving 520.
Funding Likelihood
Just because the site deems you a decent investment doesn't mean your peers (and potential lenders) will, says Pearson. After all, if you default, the lender will lose out. Consider that the average graduate leaves school with about $20,000 in student loans and $3,000 in credit-card debt, with no guarantee of a decent job. From a lender's perspective, the steadily-employed guy who wants $2,000 to refurbish his kitchen is considerably less risky. (See below for ways to improve your odds.)
Rates
The interest rate you receive from peer-to-peer lending sites depends largely on your credit score. Prosper and Fynanz lower your rate based on the level of commitment from lenders — the more people who jump on board to fund your loan, the better rate you get. Someone with good credit and an attractive listing could feasibly land a lower rate than they would with a private student loan, which start at the prime rate of 5.25% for those with excellent credit scores (say, 800 and up), but are often closer to 10%. At Zopa, you receive a set rate as low as 8.49% from the site, with contributions from other users going toward your monthly payment. Garner enough support to cover the interest portion of your monthly payment, and you could technically pay 0% on your balance.