One of the first problems that most students face when they think about going to college is how to pay for it. Traditionally, that meant supplementing whatever money their parents were able to chip in with a student loan. But lately, some lenders have cut back on the amount that they are willing to offer. Into this gap comes the relatively new field of peer-to-peer lending.
Think of it as Facebook with a purpose. Peer-to-peer lending allows students to provide a formal structure to ask their extended social networks for help in paying for school in the form of loans that students must pay back. If a student isn't able to raise enough this way, many sites allow unaffiliated third parties to make loans at interest rates that they and the student agree on. Over the last few years, peer-to-peer loans have turned into a $500 million industry.
The main peer-to-peer lending sites are Lending Club, People Capital, Green Note and Virgin Money (part of billionaire Richard Branson's Virgin empire), which make their money by charging fees that are generally less than 2% of the total value of the loan. These sites enable borrowers to search for loans in two ways. The simplest one involves sending out a message to friends and family members stating how much you expect you'll need and waiting to see if they offer to lend it to you.
The advantage of making such requests through a peer-to-peer site is that they formalize the entire process--most notably the repayment terms--and can help everyone involved avoid awkward conversations at reunions and holidays.
"These sites take the embarrassment out of it," says Mark Kantowitz, the head of FinAid, which tracks the student loan industry. "Family members won't have to nag the borrower about whether he's going to make a payment. The sites will do that for them."
Typically, friends and family members who lend through peer-to-peer sites are willing to do so on terms that are more favorable to the borrower than he will get from commercial lenders like
Another advantage of formalizing the loan process through a peer-to-peer site is that it can help students establish a credit history. It also allows more flexibility. If a family member gives a formal loan to a student and then later decides to turn the money into a gift, some sites will allow lenders to forgive the balance.
But there are some drawbacks, too. Under current IRS rules, the interest paid on conventional student loans is deductible from income taxes, as long as the borrower had an adjusted gross income of less than $70,000 (or $145,000 for married couples filing jointly.) Peer-to-peer loans from friends or family generally won't qualify as educational loans under the government's definition, which bars loans between family members.
If students can't raise enough money from their social circle, they can still let strangers bid for the chance to be their lender. Such loans generally have the interest rates in line with those offered by traditional private lenders, like Chase Manhattan and
If you are thinking about taking out a peer-to-peer loan to pay for some or all of college, here's what you need to know:
Max out federal loans first.
Peer-to-peer lending is best viewed as a supplement federal aid. Federal loans are cheaper, easier to get and have better repayment options than other types of student loans, Kantrowitz says. Interest rates on peer-to-peer loans range from 6.8%--the same rate as on a federal Stafford loan--up to more than 30%, which is higher than the interest rate on most credit cards.
Your Major May Help (or Hurt) You
Unlike traditional private loans, which are mainly based on a borrower's credit score, peer-to-peer loans may get up close and personal. That's the approach of People Capital, a peer-to-peer lender based in New York City that uses what it calls a Human Capital Score. Students will need to disclose what school they attend, their major, grade point average, SAT score and how far they are from graduating. Those that pose the lowest risk to pay back their loans--attention, straight-A computer science majors from Stanford--will get better interest rates.
Getting a loan is a matter of appealing to investors who may be assembling a portfolio of educational loans, says Al Alper, the company's president. "If they want art history majors going to a state school, that's who they are going to lend to. If I'm an investor and I want to diversify, I would include those art history majors in there as well as the M.I.T. students," he said.
Repayment Periods Vary
Because peer-to-peer student loans are relatively new, rules may vary widely. Lending Club's repayment periods run a maximum of three years. Green Note borrowers have up to 10 years to repay their loans in full. They may be eligible for consolidation with other private loans as well.
See Also:
How to Repay Your Student Loan Based on Your Income
Student Loan Repayment Options Explained
New Rules for Ditching Student Loans