From today’s Chronicle, “Prosper.com is a kind of eBay for loans, an online marketplace where lenders bid to provide loans to borrowers. Like other Internet businesses that eliminate the middleman, its proposition is that everyone involved reaps the rewards of lower costs. Borrowers get better interest rates than they’d pay on credit cards or bank loans. Lenders earn more interest than they would from money-market funds or savings accounts.”

When I first read this article, I just assumed it was another Lending Tree model where you put your loan scenario out there and lenders ‘compete’ for your business. But this is entirely different. This is person-to-person lending. If you have money to lend (up to $25,000), you can shop around for borrowers who are looking for a loan. If you want to borrow, you can post your request and people with money to lend will come to you, hypothetically at better interest rates than the banks are charging.

Besides using the Internet to democratize the loan process, Prosper offers a social networking twist, a bit like the Web site Friendster. Prospective borrowers can band together in groups to increase their appeal to lenders. Although each individual in a group is solely responsible for his or her loan, the idea is that a shame element would come into play, reducing defaults.

Potential borrowers must submit personal information and agree to have their credit rating checked by the Experian credit bureau and posted online, along with their debt-to-income ratio. As with credit card applications, people self-report their income, which is not checked. They put up profiles describing themselves, how much money they want to borrow ($25,000 is the maximum) and the maximum interest rate they’re willing to pay. There’s a bid period, typically from three days to two weeks, during which lenders can offer to fund chunks of the loan and propose what interest rate they’ll accept. When the auction ends, the site combines the bids with the lowest interest rates into a single loan.

All loans must be repaid in three years. There is no penalty for early payment. Prosper handles all the transaction processing. It charges borrowers a one-time fee of 1 percent of their loan amount. Lenders pay 0.5 percent of their loan balance annually.

Monthly loan payments are transferred directly from borrowers’ bank accounts to lenders’ Prosper accounts. Loans are unsecured. That means that, unlike mortgages or home equity loans, there is no collateral backing them up. Borrowers who default face the same consequences as those who skip out on their credit cards. Their names are turned over to collection agencies and they are reported to the credit-rating bureaus.

In a quick-glance through some of the requests, the needs range from a few hundred to $25,000, and have many small bids from multiple lenders lined up to each provide a piece of the total. I imagine that people are testing the waters with their offer of a $250 portion of the loan, where if this venture fails (or the level of trust that has developed on eBay doesn’t materialize), the lenders won’t be out a huge sum of money.

As the article says, this model may be a savior for people with less-than-perfect credit that couldn’t get reasonable rates from a bank. “There clearly is an opportunity to do AA and very high-quality lending at rates higher than what one might ordinarily receive. That isn’t at the heart of what Prosper’s marketplace will evolve into. It’s that lower-quality set that offers an enormous opportunity to really bridge the gap between lenders and borrowers.”

UPDATE: Check the comments below for a post from Megan at Zopa, the pioneer in the P2P lending category with some comparisons of the two services…

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