A decade ago, when Chris Larsen co-founded online loan broker E-Loan, he purposely took aim at traditional mortgage lenders, many of which he thought deceived borrowers and charged too much. Now, he intends to shake up a whole new swath of the financial services business. With Prosper Marketplace, a San Francisco startup he's launching Feb. 13, Larsen aims to carve out a new business -- this time by doing a number on check-cashing "payday" lenders that charge usurious interest rates.
Essentially, Larsen hopes to create an eBay (EBAY
)-style loan marketplace. Prosper matches people who need small loans, but can't get them from traditional banks, with willing lenders. Says Larsen: "We let people on both sides, borrowers and lenders, participate in the credit marketplace directly."
INVESTING IN PEOPLE. Indeed, the notion is not just to provide a new way for individuals to get small loans. It could also turn anyone with a little money into a banker. Potentially, lenders can earn an annualized 6%-and-up in monthly interest payments from a range of borrowers, providing an addition to stocks, bonds, real estate and the like. "People who have money can invest directly in other people and diversify their investments," he says.
It's a bold idea -- so bold that it's certain to draw naysayers who may wonder why anyone would lend to people they don't know. So far, only one other company, Zopa, currently operating only in Britain, has tried something like it, analysts say.
"At first, I was skeptical," says Asaf Buchner, a financial services analyst with JupiterResearch. But now, he thinks the notion could have legs if it follows the same virtuous cycle as eBay, which flourished as buyers flocked to where the sellers were and vice-versa.
ON THE BLOCK. Some consumer advocates are already cheering. "I think this could be David's stone hitting the banking industry between the eyes," says Jamie Court, president of The Foundation for Taxpayer & Consumer Rights, a nonprofit consumer-advocacy group in Santa Monica, Calif. "Chris is stripping the banks and other middlemen out of the business. It should be a huge, transformative event."
Here's how Prosper works: People who want a loan of up to $25,000, for whatever purpose they state, put it up for bid at a maximum interest rate they're willing to pay. Although they can remain anonymous to everyone but Prosper and regulatory authorities, they must submit to having their credit record checked and their credit grades -- determined from their so-called FICO credit scores -- displayed on their listing. They also can provide their annual income, so a debt ratio can be determined and also displayed.
People who want to lend money bid in increments starting at $50, usually just for a portion of the loan, to reduce risk. They also can have standing orders to provide loans of a certain size to borrowers with specific credit grades, interest rate requests, and other criteria.
PAYMENT PROCESSING. Prosper provides borrowers and lenders information on standard interest rates and default rates associated with the various credit rating levels, so they can make judgments about reasonable payments and risk levels.
When the listing ends, the bids with the lowest rates are combined to produce a single loan that's repaid over three years. Prosper draws payments from the borrower's bank account and sends them monthly to the various lenders' accounts. For its cut, Prosper charges borrowers a fee equal to 1% of the funded loans, as well as a 0.5% annual loan-servicing fee to lenders.
The site went up a week ago, with no publicity, so only about 20 loans are listed currently. They range from a request from a top credit-grade borrower for $5,000 at 6% interest to pay off a credit-card balance (eight bids) to a request by a "high risk" borrower for $10,000 at 13% interest to pay for a surgical operation (five bids). So far, according to Prosper, most of the lender bids are coming from Prosper insiders as a way to seed the market.
GROUP DYNAMICS. If a borrower fails to pay, Prosper turns the matter over to one of several collection agencies chosen by lenders. But Prosper has a new wrinkle intended to avoid bill collectors in the first place. People can form groups of borrowers -- for instance, a PTA group or alumni of a university whose collective repayment record is made public. When a group member misses a payment, the group leader is contacted first, before the collection agency.
The idea is that people are less likely to default if they know their delinquency will hurt a group of people they know, and that the group leaders will be inclined to make sure members don't miss payments. "Credit markets have destroyed the sense of commitment and shame if you don't pay," says Larsen. "So we try to make sure buyers are tightly associated with a group, whose reputation is directly impacted by one person not paying. That should dramatically lower default costs."
Some fledgling group leaders have high hopes. Jeff Dannewitz, a mapping engineer in Chandler, Ariz., just formed a small group that he hopes will include both borrowers and lenders. "It's just like being a banker, but I do it from home," he says. "I'd rather have a little more control over what and who I'm investing in than just put money in a mutual fund."
FEAR FACTOR. Some reckon they might be able to make a living as group leaders. Groups get cash incentives when a loan gets funded or an on-time monthly payment is made, and leaders can choose to keep or share rewards with the group. Gary Richardson, who sells sunglasses and goggles on eBay, hopes to have as many as 10,000 members in the group. In essence, groups could become virtual credit unions.
That's if everything goes as well as it did at eBay. Yet loans are clearly a more serious proposition than Beanie Babies or even Manolo Blahnik shoes for people on both sides of the transaction. The loans not only can involve thousands of dollars, but the consequences of nonpayment for the borrower are more severe: Prosper will report defaults to credit agencies.
Even a few high-profile defaults could scare off new lenders, just as fraud on eBay keeps some potential buyers and sellers away. Richardson, for one, believes that lenders will simply shy away from the dodgier loan requests. "There's going to be people on there who won't get loans," he says.
eBAY'S EXAMPLE. Still, there's reason to think the idea's time has come. For one, in an era when eBay has become one of the world's largest e-commerce hubs, the idea of person-to-person lending may not sound as farfetched as it once might have. After all, eBay drew many of the same doubts but has continued to thrive. So did the eBay unit PayPal, which has become the Web's largest person-to-person payment service and is now moving to become a broader alternative to credit cards online.
Plus, there's some track record now. Zopa, which started last March with a similar service in the UK, plans to enter the U.S. market sometime this year, says CEO Richard Duvall. He says that so far, the service has had no defaults thanks to rigorous screening of borrowers, while providing lenders an average 7% return. "The eBay phenomenon made people realize they could do business with people they don't know," he says.
Prosper has some seasoned backing, too. Early eBay investor Benchmark Capital has invested in Prosper, as well as eBay founder Pierre M. Omidyar's mission-based investing group Omidyar Network. Other investors include Accel Partners and Fidelity Ventures. Total venture funding in the 20-person company is about $20 million.
BANKS, TOO. Although Larsen clearly intends Prosper to be a for-profit enterprise, he hopes Prosper will put a dent in payday lenders that he thinks too often exploit low-income people. These are the storefront operations that often set up shop in strip malls and charge interest rates upwards of 300%, with marketing tactics aimed specifically at folks with bad credit histories or who don't have bank accounts.
Indeed, the Federal Trade Commission warns people away from them. And New York Attorney General Eliot Spitzer has forced several payday lenders to pay refunds to borrowers and stop doing business in the state. Will they be happy with this new competition? "I hope not," Larsen growls. If he gets some traction, banks may not be too happy either.