A new report released by the Federal Reserve Bank of Cleveland examined peer-to-peer lending, finding that this market is a growing alternative for consumers. However, the Fed was concerned that this growing market does not have the same degree of regulation or supervision as traditional channels. The Fed went so far as to liken the increase in defaults that are occurring now in P2P lending to what was seen leading up to the subprime mortgage crisis.
In its study, the Fed outlined three myths around peer-to-peer: 1) That P2P loans allow consumer to refinance other, more expensive lines of credit 2) that these loans help consumers build their credit history and improve their credit score 3) That P2P lending addresses consumers who are underserved by traditional banks.
In addressing the first myth, the Fed found that often the interest rate obtained through a P2P loan is not better than that of a credit card–one of the lines of credit P2P proponents claim their loans help with.
In addition, the report found that debt balances of P2P borrowers actually outpace their non P2P counterparts at 32 percent within two years of originating a P2P loan.
On the second myth—that P2P lending helps build a borrower’s credit score—the fed found that after obtaining a P2P loan borrowers on average experienced lower credit scores and higher delinquency rates. Rather than setting borrowers’ up for being available for other forms of credit in the future, the Fed found that P2P loans hurt borrowers’ future prospects.
When examining the types of borrowers who take out P2P loans, the Fed debunked the third myth that P2P lending helps traditionally underserved borrowers. They found that P2P borrowers are not cut off from traditional and often take advantage traditional lending services both before and after utilizing a P2P platform.
“Based on our findings, one can argue that P2P loans resemble predatory loans in terms of the segment of the consumer market they serve and their effect on individual borrowers’ financial stability. The 2007 financial crisis illustrated the importance of consumer finance and the stability of consumer balance sheets. … The overall performance of P2P loans strikingly resembles that of the subprime mortgage market before the 2007 subprime mortgage crisis,” the Fed concluded.