By MIKE GOLDSTEIN
Lending isn't just big banks, handwritten applications, and suits and ties anymore. If you're looking for a new loan in 2015, you might be surprised at just how many options you have. The world of lending has been changing rapidly over the last few years, and the traditional lending model is facing some new competition in the form of alternative lenders. Read on to find out more about what's changing.
How do traditional lending models work?
Traditional lending involves big financial institutions like banks, which typically have in-person customer service. Lending decisions are made by computers using data-driven statistical models and employees of the institution, and funds for loans are provided by the institution itself.
The decision of whether to lend to you is typically based on your credit scores, reports, income and assets. So, for example, if you have a good credit score and income, this system can work well for you.
However, problems can arise for potential borrowers who have less-than-perfect credit. According to a January report from the nonprofit Corporation of Enterprise Development, nearly 56 percent of American consumers have sub-prime credit scores, meaning they likely won't qualify for credit or financing at prime rates.
For these borrowers, it can be hard to get a loan with reasonable terms, if at all. Here are some reasons why traditional lenders may decide not to lend you money:
- You're new to credit and don't have a lengthy credit history
- You've missed payments.
- You already have a high amount of debt.
With these limitations in mind, the market has become ripe for alternative lending solutions.
What is marketplace lending?
The rise of marketplace lending has fundamentally changed the lending sphere. In the now common peer-to-peer model, companies match borrowers and investors through an online platform. The actual loan is typically issued by a bank intermediary; investors' money is essentially used to buy the loan (and the resulting payments from the borrower).
For example, Lending Club lets investors pick and choose which borrowers they'd like to invest in. The investors get an opportunity to secure a monthly return on their investment, while borrowers get the funds they need.
In many cases, online marketplace lending platforms can offer lower rates and fees because they have fewer overhead costs such as rental fees for physical branches. Online applications can also speed up the decision-making process, and the convenience of applying from your home computer is hard to beat. For example, an approved borrower who seeks a loan facilitated by Prosper typically receives funds between 3 to 5 business days after his or her loan is listed.
Alternative lending innovators
Perhaps most importantly, some marketplace lending platforms are gravitating toward even more data-driven methods for evaluating applications that may include factors that aren't commonly considered in more traditional credit models.
For example, Upstart looks at your education, job history and what you studied before making a decision, which could be beneficial for applicants with a less-than-excellent credit score.
Earnest claims that by using thousands of data points, including your employment status, how much savings you have and your history of making on-time payments, they're able to make lending less risky for themselves and more personalized for the borrower at the same time.
Vouch provides an interesting twist too. The more "sponsors" you can get to sign onto your loan, the more you can borrow and the lower your interest rates may drop. Each sponsor agrees to pay a certain amount of money to Vouch if the borrower doesn't pay back their loan. Sponsorship amounts are typically low (an average of $100). According to a Vouch spokeswoman, this system is very effective and they've seen low loss rates to date - however, if you do sign on as a sponsor and you fail to repay the sponsorship amount if required, this activity may be reported to the credit bureaus.
Marketplace lenders typically list eligibility criteria or guidelines on their websites. It's important to note that, like with banks, your credit profile is still generally an important factor in determining whether you qualify or will get preferred rates and terms.
The rise of online marketplace lenders has arguably made loans more convenient, more available and more affordable - and they may have made loans available to consumers who didn't have as many options just a few years ago.
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