Since its creation in February, Prosper, an online person-to-person loan service, has generated a healthy amount of press (Bankrate, Salon,
Newsweek). Rightly so. Prosper, and similar services expected to debut sometime this year, have the potential to revolutionize consumer lending and reduce the costs of borrowing.

Prosper offers borrowers the chance to save money by avoiding the overhead costs built into loans from traditional lenders. Prosper offers standarized three year loans with interest rates set through a competitive bidding process. Lenders bid for all or part of a loan and Prosper aggregates the funds to make the loan. Lenders then receive a pro rata share of each monthly payment.

With less than a year under its belt, it’s too soon to tell whether online person-to-person lending will grow big enough to provide meaningful competition to other lenders. However, Prosper has recently begun providing data on its loans, which can be viewed here. This feature bears watching, as it provides the number and total dollar amount of loans originated (as of this posting Prosper has originated 3810 loans for a total of $18.2 million).

Vive la Revolution!

A few questions to ponder:

Which types of lenders will Prosper provide competition to?

Credit Cards:

Prosper appears primed to give credit cards the most competition. Many loan requests cite high interest credit card debt as the reason for the loan. Because their rates are fixed, Prosper loans will spare borrowers the financial pain of having their interest rate spiked into the stratosphere under universal default. However, borrowers will need to prepare themselves to pay off their debt over three years, instead of the ridiculously long amortization periods of credit card debt.

Payday Lenders:

In its current form, Prosper seems unlikely to break the stranglehold of payday lenders. A minimum requirement for the site is a bank account and internet access. This rules out the 10 million American “unbanked” households. Further, it can take several days for enough lenders to fully fund a loan on Prosper, too long for those who need cash immediately. While there are ways to expedite loan financing on the site, it seems unlikely to be faster than a trip to the local payday lender.

Secured Loans:

Since Prosper loans are unsecured, it remains to be seen whether the site can compete for secured loans for homes and automobiles. However, there are numerous requests for home equity loans on the site, suggesting that even in the secured lending market, Prosper may make inroads.

Who are the borrowers on Prosper?

Providing an estimate of a borrower’s likelihood of default, based on credit score and historical data, serves as a cornerstone of the Prosper model. However, to the extent that Prosper borrowers are individuals who could not obtain credit through the usual channels, this historical default data may not be accurate. If Prosper borrowers default more often than the average borrower, lenders will need to adjust their rates of interest upward, cutting into Prosper's competitive advantage.

What will the reintroduction of human relationships mean for consumer lending?

Are borrowers more likely to repay individual lenders as opposed to institutional ones? Will borrowers’ personal stories influence lenders to look beyond their credit score? Will the credit union-type groups that Prosper allows borrowers to form reduce default rates? Time will tell.