Between Peers

Social networking sites embody the current zeitgeist better than anything else in American culture. They're democratic, freewheeling and techcentric--and they've made gobs of money for the fortunate few who founded them or invested early. Now, thanks to the growth of peer-to-peer lending, there might be a way for the rest of us to cash in, too.

Whether you call it peer-to-peer or social lending, the trend is in full force. There are several variations, but the basic idea is to cut out the banks as the middlemen for loans. Borrowers--often entrepreneurs looking for a cash infusion--hook up with a lender or a group of lenders and get a loan at less than the prevailing bank rate. Lenders can then diversify their portfolios and receive significantly better interest rates than they would from certificates of deposit or money market funds. The risk is obvious: default. But the limited surveys available so far show a lower default rate for peer-to-peer loans than for bank loans. And in some cases, your money can be spread across enough borrowers that any one default wouldn't be catastrophic to the total investment.

The easiest way to learn about this kind of lending is to explore the various lending sites out there. In the process, you'll probably discover whether peer-to-peer lending is right for you. If it sounds more like a burden than an interesting strategy, invest elsewhere. Even though this type of investment should make up only a small percentage of your portfolio, it takes more care and feeding than other options.

Sites like Lending Club and Prosper encourage you to spread your investment dollars among a number of borrowers. You can select specific borrowers, but the systems are set up to help diversify your risk. Another popular site, Zopa.com, connects lenders and borrowers through participating credit unions. You get a specialized c.o.d., the borrower gets a loan, and the interest rate you agree on determines how much--or how little--you help out the borrower.

You may also want to look into more specialized sites such as Kiva, which matches lenders with Third World entrepreneurs in a kind of microloan program, or Virgin Money USA, which arranges real estate, business or personal loans between families and friends.

Each site is slightly different, and like other social networking sites, your comfort level with the system is key. In the end, you could end up with a little boost in your portfolio--and the knowledge that you may have helped another entrepreneur like yourself get one step closer to realizing his or her business dream.

Next month, we'll take a look at how personal finance social networking sites can boost your portfolio.

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