A new trend in the student loan business is capitalizing on the online social-networking phenomenon to connect students with those willing to lend them money for college.

The credit crunch has driven dozens of lenders out of the student loan market. But a number of new web sites are trying to sidestep the traditional players, facilitating loans between students and anonymous investors or even friends and family members.

The latest startup player in this so-called "peer-to-peer" student lending market, GreenNote, marked its official launch June 4.

The field is still fairly small but hoping for sharp seasonal increases. Fynanz, a competitor that matches up students anonymously with investors, said it has seen a big uptick as students start piecing together financial aid over the summer, with applications for about $180,000 in loans arriving in just the last few days.

The sites are popping up as many lenders have stopped issuing federally subsidized loans. Such loans are still available, contrary to sky-is-falling predictions—but students are having to hunt for banks or turn to the federal government itself.

Meanwhile, the credit squeeze is affecting some students as they try to find private loans, which more and more students need once they hit the ceiling on cheaper federal aid.

Peer-to-peer loans are trying to step into that private-loan market, though they likely won’t amount to more than a tiny sliver of it anytime soon.

The idea is that students can secure better terms by turning to individual investors willing to back them. Investors might get satisfaction from helping out a child, relative, or friend. And if the lender knows the borrower personally, it lessens the likelihood of late payments or default.

"I do think they have some long-term promise," said Mark Kantrowitz, who runs the web site finaid.org. "I can see something like alumni using one of these sites as a way to provide loans for current students."

Indeed, three supporters of New York University have put up $500,000 through Fynanz to be available to students there.

Web sites such as Prosper and Zopa have already tried to tap into the broader world of peer-to-peer lending, using the internet to match up people who need to borrow for a range of reasons with strangers willing to back them.

Fynanz, which debuted in March and currently operates in 16 states, called itself the first such service to target student loans. The site evaluates students for credit risk and matches them with an individual investor or investors, who bid to finance the loans.

"It’s been a very eye-opening experience as to just how many people are out there who actually want to fund students," said CC Chaman, Fynanz’s chief executive.

He said even nonprofit lending agencies have concluded that Fynanz is an effective way to get their money to students and are putting up funds.

GreenNote, the site that debuted June 4, works differently. It focuses largely on formalizing and servicing loans between people who already know each other.

Students who need a private loan and have a bad credit history, but know people willing to lend to them, might find the terms attractive. There’s no credit check and the interest rate is 6.8 percent, the same as a federal Stafford loan and better than most private loans and federal PLUS loans for parents.

GreenNote helps students conduct a "pledge drive" to raise capital. The downside is that students might not be able to borrow all they need. GreenNote doesn’t really get students access to money they don’t already have access to; it essentially organizes the transactions among family and friends, although there is a "public" profile option that allows outsiders to loan money through the site. If students can get family and friends to just give them the money—or lend it at less than 6.8 percent—that’s obviously a better deal.

There also are fees: 1 percentage point of the interest return for lenders, and 2 percent up front for borrowers. The interest isn’t tax deductible. And lenders beware: GreenNote provides no guarantees against default.

Akash Agarwal, CEO and founder of Redwood City, Calif.-based GreenNote, says many students have family and friends who are willing to subsidize their education—but only so far. They want a reasonable loan rate and a formal arrangement.

Kantrowitz, of finaid.org, cautions that fees and other factors might make such loans less appealing, but he says there is value in having an outside party service loans between acquaintances, to avoid conflicts.

Links:

Fynanz

GreenNote