Michelle Deininger never planned on being a repo man.
But that's the role she played after agreeing to sell her 272,000-mile Honda Civic to her younger brother. Like most people who lend to relatives, Deininger didn't have her brother sign anything - she just handed over her car and gave him a month to pay her $500. The check never came.
After a couple of months, Deininger, 40, who is now a stay-at-home mom living in Cohasset, took her extra key, bicycled to her brother's house, and repossessed her car in broad daylight. The incident ended her lending days, she says.
"No more loans, just gifts," she says.
Age-old wisdom counsels against lending to loved ones. But wisdom, of course, isn't always heeded: The Federal Reserve estimates there are more than $89 billion in outstanding loans to friends and family members. Adding to that, less than half of those outstanding personal loans are fully documented, according to the Fed, making it hard to know what percentage actually gets repaid.
As the credit crunch worsens, some financial planners say more people are turning to their families for help. That is spurring further growth of a small group of person-to-person lending websites, which make it possible to borrow money or lend to family members, friends, or strangers without having to manage the uncomfortable details of setting terms and collecting loan payments. The most popular of these are Virgin Money, Prosper.com, and Lending Club, but other such lending sites are on the way - most notably Zopa.com, a successful UK lending marketplace that for some time has promised to launch in the United States this year, and soon-to-be launched sites such as GlobeFunder.com, Loanio, and Community Lend (in Canada).
Here's how the sites work: for a fee, the companies help borrowers and lenders set up interest rates; document and record loans; create repayment schedules and tax paperwork; and in most cases, set up automatic electronic payments. The companies also help with collections when necessary.
The oldest of these sites, Virgin Money of Waltham, formerly known as Circle Lending, is designed to facilitate personal, business and mortgage loans between relatives and friends. chief executive Asheesh Advani says the company manages $200 million in loans, with personal loans averaging $20,000 and first mortgages running at about $250,000.
About a third of Virgin's customers use the service for personal loans, most of which are unsecured - meaning they're not secured against borrower's assets. Virgin's default rate hovers at a low 1 percent for mortgages and 5 percent for personal loans, far lower than the average default rate of 14 percent for unmanaged loans between family and friends, according to Monitor, a Cambridge consulting firm. And there's no cap on the amount a lender can provide for a Virgin loan: In fact, Virgin has serviced a few $1 million, 40-year mortgages, Advani says.
Closing fees range from $99 for basic personal loans to up to $2,499 for what it calls "retirement mortgages," which basically are reverse mortgages provided by a family member. In a reverse mortgage, the bank pays a homeowner a monthly amount over time and builds equity in the person's house. In certain circumstances, it's a good solution for a cash-strapped elder. Virgin's retirement mortgage is basically the same thing, except that the relative is acting as the bank - i.e. the son pays his mother $500 a month and builds up equity in her home, while earning, say, 5 percent on the payments.
There are advantages to using a site like Virgin. While bank loan closing fees vary and can be zero, families typically set lower rates than banks - generally at about 6 percent - making the service a good deal for people with average credit or debt-to-income ratios that would incur higher interest rates for bank loans. At the same time, a lender benefits by receiving interest higher than it would earn on a savings account or CD. However, if you have great credit and can qualify for a zero percent promotional credit card, that can be a better bet (provided you're not trying to keep interest payments in the family.)
But family loans aren't just attractive to people with poor credit. Even for people with good credit, bank fees for reverse mortgages are high - they can be more than 10 percent of a property's equity. And in some circumstances, the service lessens the borrower's risk. For instance, if a borrower misses a payment, the service will revise the payback schedule so that the borrower can "catch up," unlike a bank, which within months will foreclose on a mortgage.
Financial planner Deb Maloy of Wakefield-based Maloy Financial Services believes Virgin Money's "retirement mortgage" is less risky, and more economical, than a bank-sponsored reverse mortgage. Other planners also say using Virgin Money to manage loans mitigates much of the risk of default for the lender, since borrowers are more likely to repay, and do so on time, when payments are automatically debited.
While Virgin's bread and butter is family loans, other person-to-person lending sites are less geared toward intra-family lending but still can be used that way. Prosper.com and Lending Club offer different twists on the idea of a marketplace for loans between individuals in which strangers and family members can bid on a portion of a loan. Prosper.com, an eBay-like auction market for loans, has almost $100 million under management with an average loan size of $7,000; Lending Club, which launched in May, will manage $6 to $8 million worth of loans by year's end, says CEO Renaud Laplanche.
On Prosper.com and Lending Club, borrowers post the amount they want to borrow. On Prosper.com, lenders bid on the loan, often underbidding the borrower's requested interest rate. Last week on Prosper, a woman with the screen name EnjoyLife68, for instance, recently was seeking $10,000 at an interest rate of 12 percent to remodel her home. (At press time, 96 people had bid on her loan, which was 88 percent funded.)
Lending Club, in contrast, sets interest rates according to the borrower's credit rating. Usually, lenders on both sites loan money in $50 increments, which spreads out their risk. Thus, a college student seeking, say, $4,000 to consolidate credit card debt, could get it from 80 lenders.
Like Virgin Money, both Prosper.com and Lending Club document and record the loans, do the tax reporting, and collect payments automatically. Both, however, cap their loans at $25,000. All loans on Prosper.com are three years in length. Both sites charge lenders a fee of up to 1 percent of the loan; fees range from .75 percent to 2 percent for the borrower, depending upon the borrower's credit rating.
Just like banks, lenders on both Prosper.com and Lending Club choose the borrowers they're willing to lend to, based on their credit rating and other financial information. Both vet the borrowers but don't guarantee they'll pay up. On both Prosper.com and Lending Club, lenders are making unsecured loans. Laplanche says interest rates on Lending Club average about 9 percent right now, about three to four points lower than the average bank loan. Prosper.com rates range from about 7 percent to more than 20 percent, Prosper.com CEO Chris Larsen says.
Overall, analysts say these types of person-to-person sites can be a good tool for those looking to lend to relatives. Deininger, for one, wishes these sites had existed 15 years ago when she repossessed her brother's car. "An attractive interest rate and a bad-cop presence will be a good thing for people," she says.
But not everyone considering a family loan should use a person-to-person site. Lenders doing larger loans and mortgages will benefit from the arm's-length nature of all of these third-party services. But in the case of very small unsecured loans between family members - such as Deininger's loan to her brother - the sites aren't always necessary. The conscientious could save money and heartache simply by writing their own promissory notes and figuring their own repayment schedules.
Either way, John Napolitano, who owns US Wealth Management in Braintree, recommends lenders overcome the squeamishness of asking a relative to document a loan.
"People don't document loans, because they feel stupid saying 'I want to have you sign this note,' " he says. "But even dumber is sitting there at Thanksgiving dinner with the guy who hasn't paid you in a year.