Peer-to-peer lending has advantages for both sides

Despite all the recent talk of recovery, getting a loan is still more difficult than it used to be.

A recent analysis by The Wall Street Journal found that the amount of loans held by 15 large U.S. banks was down 2.8 percent in the second quarter of this year, and the majority of loan volume in April and May was for mortgage refinancing and renewal of credit to businesses -- not for new loans.

Simultaneously, we're also earning less interest on any short-term savings we've managed to stash away, whether in a money market or a certificate of deposit.

So some borrowers are turning to peer-to-peer (P2P for short) lending. It's a practice of allowing individuals to borrow money from and lend money to other individuals, generally over the Internet. The financial-research company Celent has predicted that we'll see more than $5 billion in these kinds of loans by 2010, up from less than $300 million in 2006.

There are a lot of advantages associated with P2P lending, including low interest rates for borrowers and high returns for lenders.

If you want to borrow:

• How it works. You go to a P2P Web site and post the amount you need to borrow. Lenders then bid by interest rate to fund your loan. The two leaders in the marketplace, LendingClub.com and Prosper.com, will allow you to borrow as much as $25,000 at a time at a fixed rate and give you three years to repay the funds. There are closing costs involved of about 3 percent. Most borrowers are using the site to consolidate unsecured debt, such as credit-card debt.

• Credit scores still count. This isn't an easy way out for someone with a bad credit history. LendingClub.com and Prosper.com require borrowers to have a minimum credit score of 660 and 640, respectively. And, as with traditional loans, the lower your score, the more you pay and, if you default or pay late, the information will end up on your credit report.

• Consider borrowing from family and friends. Another player in the P2P market is VirginMoney.com. It's a facilitator that allows you to borrow from friends or family but handles the transaction in a businesslike manner. For a fee of $99 to $199, this site will draw up a contract and a repayment schedule for personal, student, business or real estate loans. You and your lender get to decide if there will be interest involved and, if so, how much and whether you want the loan to show up on your Experian and TransUnion credit reports.

If you want to lend:

• Do your research. You should have a good grasp of what separates a good credit score from a bad, and how the borrower's debt-to-credit ratio factors into the equation, says Curtis Arnold, author of "The Complete Idiot's Guide to Person-to-Person Lending." I suggest going to myFICO.com, which crunches the numbers for credit scores. Also, you should start small and broad. If one person defaults, you won't lose your entire investment.

Diversify. The returns on investment posted by P2P sites look pretty attractive. Prosper's return is an average 7.06 percent, Lending Club's 9.62 percent. But understand that although long-term performance is the best barometer of future results, this is such a new market that long-term results don't exist yet. That's why even fans say it should represent only a small slice of your asset allocation.

Jean Chatzky is an editor-at-large at Money magazine and serves as AOL's official Money Coach. She is the personal finance editor for NBC's "Today" show. Her Web site is http://www.jeanchatzky.com.