Peer-to-Peer Lending (P2P Lending) 101: The C’s of Credit

July 3, 2007

You want to be your own banker? Fine. Now that you’ve joined Lending Club to either lend or borrow, see if you know what bankers know and if you’d like to think how they think. I’m not suggesting that there is only one way to think about money.

Banking—lending—is over 4,000 years old, why reinvent the wheel when we can benefit from the structured knowledge that has worked for so long? The oldest recorded bank loan, inscribed on a clay tablet found in the temples of Babylon around 2,000 B.C..

This involved two shekels of silver borrowed by Mas-Schamach son of Adadrimeni, from the sun-priestess Amat-Schamach daughter of Warad-Enlil, at the Sun-God’s interest, payable at the time of harvest.

Having said that, a good place to start your person-to-person lending education is with the four C’s of credit. Other C’s have been added over time, but these four (actually three, as will be apparent later) are enough for your purposes here at Lending Club:

1. Character. Character here refers to a person’s attitude and personal values in relation to his or her credit commitments. I would like to underscore the phrase “credit commitments,” because as long as the applicant has consistently met credit obligations, his or her personal lifestyle should not get in the way of your lending decision.

2. Capacity to Pay. For an employed applicant, capacity is estimated using disposable income versus the amount of the proposed monthly loan payment. For a self-employed applicant, the net business income, stability of the business, and the person’s managerial ability are considered.

3. Capital. Capital pertains to a borrower’s assets. A person’s properties and other valuables are indicators that the applicant has sufficient resources to live a good life and make a good living. The logic here is that a homeowner is more likely to be a good borrower than somebody who is not similarly situated.

4. Collateral. Sometimes, personal property and other assets can be used to secure a credit obligation. Collateral provides a motivation for the borrower to repay the loan, as well as a source of repayment for the lender if the borrower is unable to pay back the loan. Since Lending Club loans are unsecured at this time, collateral is not your direct concern.

These principles should serve you well as a borrower or a lender on Lending Club.

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