Five Things to Know About Getting a Person-to-Person (P2P) Loan

This is a guest post from Beverly Blair Harzog, who is a contributing editor at CardRatings.com and co-author of the book “The Complete Idiot’s Guide to Person-to-Person Lending.”

Five Cent Nickel has previously featured articles on Alternative Approaches to Investing with Lending Club and My Lending Club Loan Selection Criteria.

When I was offered the chance to co-author The Complete Idiot’s Guide to Person-to-Person Lending, I jumped at it. I just love the whole concept of social lending.

The person-to-person (P2P) lending industry has changed a lot over the past couple of years, especially since the SEC began regulating the industry. Social lending isn’t quite as personal as it once was, but at its core, it’s still all about people helping people. And if you’re the borrower, you have a chance to explain to lenders why you need the money and why you’re a low-risk borrower. You can try this at a bank, but it’s tough to pull that off right now.

Here are five things you need to know before you apply for a P2P loan:

#1: Check your credit report

You’re can get a free credit report each year from each of the three major credit bureaus (Equifax, Experian, and TransUnion) by visiting AnnualCreditReport.com. You should check your report before applying for a P2P loan to make sure there aren’t any errors. If you find any incorrect information, you will need to correct the errors on your credit report before applying for a loan.

You’ll also want to know what’s on the report, especially if you’ve made a late payment recently. Basically, you want to find out ahead of time if there’s anything on your credit report that might keep you from qualifying for a P2P loan, or which might need explaining.

#2: Check your credit score

Unfortunately, your credit score doesn’t come with your credit report. While you can sometimes find offers for free credit scores, you might end up having to pay to see your score. I would recommend checking both Equifax and TransUnion. Why two? Because each bureau may have a different score for you due to differences in your credit reports.

Experian uses a different scoring system. Their site often has promos for getting your score for as little as $1, but beware… If you sign up for this deal, you automatically get a free trial subscription to their credit monitoring service. If you don’t opt out before the trial ends, you’ll get billed $14.95 per month.

The reason you want to know your score before you travel further along the P2P path is because the major sites have minimum FICO score requirements. To get a loan with Lending Club, you need a minimum FICO score of 660. At Prosper, you need a minimum score of 640.

#3: Determine your debt-to-income ratio

This sounds complex, but it’s really simple. Your debt-to-income ratio (DTI) compares the amount of money you earn to the amount of recurring debt you owe to creditors.

Here’s an example:

Let’s say James makes $72,000 per year as a manager for a paper products company in Scranton, Pennsylvania.

Gross monthly income: $6,000
Recurring debt expenses: $2,200
DTI ratio: $2,200/$6,000 = 36.7%

Honestly, James has a problem because 36.7% is high. Lending Club, for example, requires a 25% DTI ratio. Think of your DTI ratio as the opposite of your FICO score—the lower the number, the better. If your DTI ratio is over 25%, you might not be in good enough shape to get a loan.

#4: Research P2P lenders

Researching P2P lending websites has never been more important. Some of the websites I wrote about in my book have disappeared from the P2P scene. Not all of them had viable business models. But the big ones — Lending Club and Prosper — are still there. If you’re considering a site that hasn’t been around long, research it to death. Seriously.

In fact, unless you’re seeking a loan to pay for something like college, I suggest sticking with either Lending Club or Prosper. At the moment, I lean towards Lending Club. In the recent past, both Lending Club and Prosper had to redesign their lending platforms to comply with the SEC. Lending Club made the change first and has had more time to work out the kinks. But the management at Prosper is a very capable group, so I expect the site will be fine in the long run.

Whichever P2P site you choose, spend time on the site and read the FAQs. If the site has a forum, participate and ask questions. And don’t hesitate to e-mail the site and ask more questions. It’s also a good idea to ask to speak with someone who got a loan on the site. This is the way to get the real scoop on what it’s like to borrow through that company.

If you’re looking for a loan to pay for college, you should also take a look at PeopleCapital.com. This P2P site is SEC compliant and specializes in providing student loans. Instead of using a FICO score, it uses a Human Capital Scoreâ„¢. This score is based on future income potential and includes factors such as your GPA. Lenders use this score to determine if a student has the capacity to repay a loan.

#5: Know that you can repay the loan

Don’t let desperation for a loan lead you to take on a debt that you can’t repay. Be sure you have a budget—on paper or online—that shows how much you can easily spend on a monthly P2P loan payment. Look at the numbers closely and make sure you can handle this financially.

If you fail to make a loan payment, P2P lending websites will report you to the credit bureaus and ultimately send you to collections. And yes, this will make your FICO score go down. But if you make your payments on time, you’ll have an opportunity to increase your FICO score.