One of the big news stories that everyone is constantly discussing is the lack of credit being lent during this recession. Despite the numerous attempts by the government to pump money into the institutional lenders, credit remains tight. Yet while the government and big banks are trying to maintain the status quo on lending, a dark horse is quietly gaining on traditional lenders, and providing much needed credit to cash strapped consumers.

This movement, called person to person lending (or P2P as we’ll call it), is all about matching people who have money to invest with those who wish to borrow money, and drawing up an agreement for mutual benefit. Often both parties will find that the rates are much more agreeable than what they could have found at any bank. Investors or lenders on average make 9%-20% returns. Borrowers find similarly agreeable rates.

P2P lending works as an investment vehicle because the loan is considered short term, usually no longer than three years. And no P2P lending institution deals in home loans, as it would create a totally different loan class that might not be beneficial to it’s members. The loans I have seen and funded have ranged from debt consolidation loans to home remodeling loans, and even included college expenses. In general, it is loans that banks generally won’t touch because of a higher risk factor; but in exchange for the risk factor, you can lock in a higher rate of return.

Several companies have been set up to capitalize on this growing trend. The two pioneers are Prosper Marketplace and Lending Club. I have used both, and find their services to be top notch. They act as the eBay of loans, and lenders can search through loan application listings to decide which ones they will invest. Lenders can then invest as little as $25, and with the addition of potentially hundreds of others investing in the note, the loan will get funded. Prosper or LC will then collect the payments every month and distribute it accordingly. Prosper also has a feature which allows you to set up a “portfolio plan” which will automatically invest in loans that meet your criteria. This is wonderful if you don’t have time to wade through the many loan opportunities.

People are starting to awaken to the possibilities P2P lending gives them. Many investors choose to invest in this industry because they find they can’t get better returns in the stock market or from CDs. Personally, I liked the idea that I will get income every month as interest on the loans I made.

P2P lending is an investment and lending vehicle which has been approved by the SEC. In fact, Prosper CEO Chris Larsen worked with the SEC to help create an entire regulatory class for this emerging industry. Rest assured, it is not a passing fad or scam.

P2P lending has already gained a firm foothold in the credit markets. Already at $4 billion in loans, it is slated to double in the next several years. And as the credit markets continue to restrict lending, more people will turn to this industry to meet their needs. It is a phenomenon which I think will forever change the face of American finance.