Would you lend money to a friend? To your brother-in-law? Or to a perfect stranger?

An increasing number of people are answering those questions with a resounding, "Yes!" Over the past three years, lending directly to friends, family members and even total strangers has become a popular way of earning a decent return, while helping out specific people strapped for cash.

Such direct loans are being arranged, executed and serviced through an innovative Web-based model known as peer-to-peer lending.

P2P lending brings together the ideas of social networking and micro-credit, matching people who have money to lend with people searching for a loan. P2P eliminates the middleman — the banking industry — by allowing loans to be made directly from one person to another.

Cutting out the banker creates a "win-win" for the lender and the borrower. The lender earns more interest than can be earned on bank savings, while the borrower pays less interest than would be charged on a bank loan (assuming the borrower could even get a bank loan.)

P2P lenders also get the satisfaction of helping a specific person start a business, pay off higher-interest debt, or remodel a house for a growing family.

The biggest player in the budding P2P industry is Prosper.com, launched in 2006 by Chris Larsen, co-founder and former CEO of E-Loan. Larsen calls Prosper "an eBay for money and credit."

As of July 31, 2009, the site had more than 900,000 members and had helped arrange almost $180 million in P2P loans. (Prosper generates its revenue by charging borrowers an upfront fee and lenders a small percentage of the loan balance.)

But it hasn’t been a smooth ride. Prosper was effectively shut down in late last year after the U.S. Securities and Exchange Commission demanded the company register as a seller of securities. That process took nearly nine months. Finally, with SEC approval, Prosper resumed facilitating P2P loans in July.

Here’s how P2P lending works. Would-be borrowers shop for a loan by posting details (for free) about why they need a loan, how much they want to borrow and what interest rate they're willing to pay. Lenders then bid, offering to fund the loan at the borrower's desired interest rate, or lower.

Usually, loans are funded by pooling money from many individual lenders. A $5,000 loan, for example, might be funded by 100 different people who've each put up $50. Some Prosper lenders have portfolios that consist of hundreds of such "microloans."

The advantage of this micro-credit model is diversification, which greatly reduces a lender's exposure to default risk. In the previous example, if the borrower failed to repay the $5,000 loan, the most any of the 100 lenders could lose is $50.

To help lenders make informed lending decisions, Prosper posts borrower profiles that include a credit score (minimum allowable score is 640), debt-to-income ratio, and information about any current and past delinquencies. The site also assigns each potential borrower a risk rating, ranging from AA (excellent credit) to HR (high-risk).