Peer-to-Peer Student Loans

Peer-to-peer (P2P) student loans are a type of peer-to-peer loan. Peer-to-peer student loans can be a practical alternative to more traditional forms of education financing and credit cards for students and parents who have a short-term need for small amounts of funding. Peer-to-peer student loans are popular for purposes that might not qualify for federal or private student loans, such as enrolling in an unaccredited school, paying a debt owed to the college before the student can reenroll, graduate or transfer to another school or borrowing by an international student.

Peer-to-peer lending is a form of crowdfunding, where consumers borrow money from many individual lenders, each contributing small amounts of money toward the borrower’s goal. The lenders may include relatives, friends, colleagues, community organizations and complete strangers. This is in contrast with traditional student loans, where the money is provided by a single lender, such as a bank or other financial institution, government agency, college or university. Peer-to-peer lending is also known as person-to-person lending, social lending and microlending.

There are two main types of peer-to-peer loans: friends and family loans and stranger-to-stranger loans.

  • Sites that support friends and family loans provide formal documentation of the loan, such as a signed promissory note with specific terms and conditions that complies with federal and state laws and regulations. These sites may also provide servicing of the loans, such as collecting payments and reporting on-time and delinquent payments to credit reporting agencies.
  • Sites that support stranger-to-stranger loans help match borrowers with lenders. Interest rates on stranger-to-stranger loans may be higher than interest rates on friends and family loans. Eligibility for stranger-to-stranger loans may depend on the borrower’s credit scores, although minimum credit scores may be lower than on most private student loans. Peer-to-peer student loans are also an option for students who are unable to obtain a creditworthy cosigner.

Disadvantages of Peer-to-Peer Student Loans

There are several disadvantages to peer-to-peer student loans from the borrower perspective.

  • Difficulty attracting funding. Less than ten percent of peer-to-peer student loans are fully funded. Lenders diversify their investments to reduce the risk of default by lending small amounts to numerous borrowers. Borrowers often need funding from dozens and dozens of lenders to get fully funded. Borrowers seeking smaller loan amounts at higher interest rates are more likely to be funded.
  • Eligibility for the student loan interest deduction. Peer-to-peer loans between family members are unlikely to qualify for the student loan interest tax deduction or to qualify for the exception to bankruptcy discharge, since the definition of “qualified education loan” under the Internal Revenue Code of 1986 at 26 USC 221(d) excludes “indebtedness owed to a person who is related . . . to the taxpayer.” Stranger-to-stranger loans, however, will most likely qualify for the student loan interest deduction.
  • Short-term loans. Most peer-to-peer loans are short-term loans, typically requiring repayment in 1-3 years. Some peer-to-peer lending sites have created more specialized student loan programs with longer repayment terms.

Sources of Peer-to-Peer Loans

Most of the peer-to-peer lenders that specialized in peer-to-peer student loans stopped making peer-to-peer student loans in the U.S. because of changes in disclosure requirements. For example, GreenNote started as a friends and family peer-to-peer lender, but now enables students to solicit donations from their personal network in a more traditional form of crowdfunding. Fynanz, now known as LendKey, previously specialized in peer-to-peer education loans, but subsequently created CU Student Loans to combine student loans from more than 100 non-profit credit unions into a single interface.

There are still several peer-to-peer lenders that will make P2P loans, albeit not specialized for higher education. These include Prosper and Lending Club, as well as the friends and family lender LoanBack. In the UK, there are RateSetter and Zopa. Kiva still makes loans to individuals in developing countries.

There are two lenders of private student loans that were inspired by the peer-to-peer model, SoFi and CommonBond. Both claim that they enable alumni to invest in current students and that this social connection yields benefits for borrowers and investors. It is unclear, however, how much of the loans are funded by alumni and how much by institutional investors and venture capital.

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