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With Bank Rates Low, Is Peer-To-Peer Lending Right for You?

Barbara Marquand | guest writer for GoTalkMoney

With bank rates at miniscule levels on CDs and money market accounts, a double-digit rate of return outside the stock market sounds unbelievable.

Yet some peer-to-peer lending investors boast returns of 12 percent or more, and their success is turning heads and drawing others to the table.

Peer-to-peer lending has been around since early civilizations when neighbors made loans to one another, but the Internet has transformed the practice into a fast-growing cottage industry.

P2P lending sites, such as Prosper and Lending Club, connect borrowers with lenders -- investors like you. The industry took off in the last few years as banks tightened credit, leaving borrowers with little access to loans for cars, student bills, and debt consolidation, and investors searched for alternatives to the stock market and wee returns on CDs and high-yield savings accounts.

Prosper.com in San Francisco has almost 1 million members and more than 32,000 funded loans totaling over $194 million. Lending Club in Redwood City, CA recently announced it passed $10 million in monthly loan fundings for May 2010.

Beating Low Bank Rates

If you had invested $10,000 in Lending Club Notes in June 2007 and continued to reinvest your returns, you'd have made over 9.5 percent net annualized returns, outpacing a high-yield corporate bond index, the NASDAQ and the S&P 500, Lending Club says.

Prosper estimates returns of 6 percent to 16 percent.

To invest on a P2P lending site, you open an account and then build a portfolio. With $5,000, for instance, you could diversify over 200 loans at $25 each. You get payments, including principal and interest over the three-to-five year loan terms.

Despite the glowing returns boasted by the industry, the decision to invest shouldn't be a slam dunk. Here's what you need to know:

Your Money Investments: Are They Safe in a New Industry?

Although P2P sites boast high rates of return for investors, this is a new industry without a long track record of stability and success. Companies like Pertuity Direct have come and gone quickly. Prosper stopped accepting new applications for several months starting in October 2008 while it waited for approval of its registration paperwork with the Securities and Exchange Commission. British company Zopa left the U.S. market soon after it launched here.

Risk

Like credit card debt, the loans you make on P2P sites are unsecured, which means if the borrowers default and can't pay off the balances, you get nothing. Although the P2P sites check borrowers' credit scores and you get to see applicants' credit information and view their personal stories, you still take a risk when you hand over your hard-earned dollars. If the most highly-trained bankers make some bad loans, chances are you will, too.

Liquidity

Need your money back? That could take some time. You have to sell the loans through the site's trading platform if you can't wait until the end of the loan term. Stick to savings and money market accounts and CD ladders as vehicles for emergency savings.

Don't get carried away by the much-touted rates of return. Understand the risks and limitations of peer-to-peer lending before you invest.

Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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