Color of Money: The Risks of Online Lending

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ALEX COHEN, host:

Back now with DAY TO DAY.

Need a little extra cash to buy a car or pay off that visa bill and you don't want to deal with the bank? Well, you may want to consider person-to-person lending, otherwise known as P2P. One research firm predicts the demand for P2P loans to pay off credit card debt may quadruple to $159 billion over the next five years. But before you jump into the P2P game, here's some advice from our personal finance contributor Michelle Singletary.

Welcome back, Michelle.

MICHELLE SINGLETARY: Thank you. It's good to be here as always.

COHEN: So P2P. Can you tell us a little bit more about this? Most of these loans are found online. How do they work?

SINGLETARY: Right. This is basically formalizing what lots of us have already done privately - lending to relatives, to friends or co-workers. The twist is that you do it on the Internet. And there is two type of models. There is people who lend to strangers - people they don't know. And then one model by Virgin Money USA where you only lend to people you know - relatives, friends, and perhaps co-workers.

COHEN: So what's the benefit of going this P2P route?

SINGLETARY: You get scheduled payments, and also you get an interest rate. Often times when you lend to family and friends, you say, oh, here's the money. Pay me back when you can. There's no interest charged. When you go through these Web sites, they formalize everything. In one case they do - say you do a mortgage for a friend or family member, they do all the paperwork associated with registering that mortgage, all the things that you would need to do to make it like a real formal loan that you might get from a financial institution.

The difference is, for the borrower oftentimes the interest rate is less than what you would get from a financial institution. And on the lender's side, those who are lending the money, they get more for their money than, say, putting it in a regular checking or even a high-yield saving account.

COHEN: Sounds pretty win-win. And you're helping out your family, your friends. There's got to be some risk here somewhere.

SINGLETARY: Oh, there's definitely risk.

(Soundbite of laughter)

SINGLETARY: You know, here's the thing. The default rates in this area is still higher than it would be from a financial institution because these are not people experienced in judging who is credit-worthy. And then you toss in the personal relationship angle. You know, lending to your sister, or Peaches and them, you know - I mean...

COHEN: We've been there before, yes. Don't want to play repo man with your mom.

SINGLETARY: Exactly. Are you going to go and get that car that you've lent them the money for? And then the other thing is, you know, I was looking at some of the reasons why people wanted some of these loans. And it allows them to use borrowed money to pay off borrowed money. And then I saw one entry where one woman was asking for - I think it was like $3,500 for a vacation that she needed. You don't need a vacation if you have to borrow the money for it.

COHEN: I need a vacation.

(Soundbite of laughter)

SINGLETARY: Well, you know, I understand that people feel as if they're entitled to a vacation. But a vacation is something you should pay for cash, not borrow money. And even in her case, I think the interest rate was 14 percent, which might be less than what she might get on her 18 percent credit card. But nonetheless, that's something that she ought to be saving for, not borrowing the money for.

COHEN: Well, so much for my plan to ask you for a hundred bucks, Michelle Singletary. Thank you very much, Michelle.

SINGLETARY: You're welcome. You're not going to get it. I will tell you, get a job, girl.

COHEN: Foiled again. Michelle Singletary is our regular expert on personal finance. And she writes the nationally syndicated column The Color of Money.

Thanks, Michelle.

SINGLETARY: You're welcome.

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