Prosper.com, The Online Loan Alternative

"Neither a borrower nor a lender be," William Shakespeare wrote. If the Bard could have logged on to Prosper, the oft-quoted advice from Hamlet might have been a little different.

Prosper is an online market for loans, doing for money what eBay did for Beanie Babies. Prosper connects people who want to borrow money with people who want to lend it, all without going through a bank.

"Until now, financial institutions have controlled who is able to obtain credit and the rates people pay," said Chris Larsen, chief executive officer and co-founder of Prosper, in a press release issued at the company's February 2006 launch. "Over time, this one-sided control has bred inefficiencies and excessive margins - leading to higher rates for borrowers, and restricting people who have money to lend from entering and generating income from this vital and lucrative market."

"Prosper gives people the opportunity to take back the marketplace for consumer credit," said Larsen. "By providing the platform and tools for an efficient marketplace created by and for people, Prosper aims to make consumer lending more financially and socially rewarding for everyone."

At Prosper, borrowers can get three-year unsecured personal loans from $1,000 up to $25,000, with a minimum of paperwork and no prepayment penalty. Loans run the gamut from debt consolidation, business expansion and college tuition to home renovation. Lenders can invest as little as $50 on up to $25,000 and can diversify their loans over a variety of borrowers. Instead of making one $5,000 loan, the money can be lent in $50 increments to 100 borrowers. Loans may earn better rates than funds invested in money market accounts or certificates of deposit.

So how does it work? Borrowers and lenders register online at www.Prosper.com for a free membership, with identity verification performed by Prosper through credit bureaus and other databases.

Borrowers then create loan listings, stating the desired loan amount, the maximum interest rate they'll accept, their intended use for the funds, and the auction duration. Just like eBay, borrowers can even post photos of themselves or their businesses. Prosper posts a credit grade, debt-to-income ratio and historical default rates on each listing.

Then borrowers wait for lenders to bid down their preset maximum interest rate. If a loan is funded for the full amount, Prosper combines the bids with the lowest rates into a single loan. Money is deposited into the borrower's bank account by electronic funds transfer, typically within a week.

All administrative work including collections is handled by Prosper, which charges borrowers one percent of the loan amount, deducted upfront as a transaction fee. Lenders pay an annual loan service fee of 0.5 percent.

As with eBay, options abound for borrowers and lenders. Prosper encourages borrowers to join groups, which earn a reputation based on their members' repayment records. Groups are a collection of people organized around a common interest, such as volunteer firefighters, college alumnae or even family members. Group leaders issue membership invitations and help members write loan listings that attract lenders. Group leaders are compensated by Prosper based on the group's loan repayment performance. Maintaining the groups' reputation gives borrowers an added incentive to make on time payments, which should result in lower interest rates.

Lenders can create standing orders, or automatic bids authorizing Prosper to bid on loans meeting a lender's specific criteria. Lenders can pick the interest rate, credit grade, group affiliation and the amount bid per listing. Standing orders save time, as Prosper automatically places a bid when a loan listing meeting the preset conditions is posted. They also allow lenders to spread their risk over many borrowers.

Headquartered in San Francisco, Prosper was launched in February 2006 by Chris Larsen and John Witchel, long-time technology entrepreneurs. Before becoming Prosper's chief executive officer, Larsen co-founded E-LOAN, the home mortgage and auto loan website. Witchel, Prosper's chief technology officer, has developed a number of high performance computer applications.

Recent announcements by the company attest to Prosper's success. In October 2006, membership hit the 100,000 mark with more than $20 million in loans generated since startup. The company boasts a default rate of less than one percent.

If you want to borrow, here are some things to consider. It can take several attempts before a loan is fully funded. Prosper automatically deducts loan payments from your bank account, so you must have sufficient funds in the account. If you are late with a payment, you'll be hit with late fees. The account can be turned over to a collection agency if payments are not brought up to date. Late payments are also reported to a credit agency, which can negatively affect your credit score.

Lenders should know their tolerance for risk before signing up with Prosper. There is no guarantee that your loan, which is not backed by any collateral, will be paid back. Prosper is not insured by the Federal Deposit Insurance Company as banks are, although the money in lenders' accounts up to $100,000 is covered by FDIC pass-through insurance from Wells Fargo Bank. Since Prosper allows loans to be paid off early with no prepayment penalty, you may not receive the return you had expected on your investment. And taxes due on the interest income will cut into your return.