As most of my clients know, I would prefer that everyone carry a zero balance on their credit cards. When implementing a financial plan, addressing a client’s credit card debt typically comes early in the conversation.Why? A high-interest rate credit card is like rowing a boat with holes in the bottom. It’s just so tough to move the boat forward because it’s taking on more and more water – even if you’re bailing out some of the water (paying your monthly minimum), it’s not enough to keep the boat from sinking.
If you’re carrying a lot of credit card debt - or an investor looking for a way to earn a higher interest rate on your cash - you may want to explore Peer-to-Peer (P2P) lending. What is it, and how does it work?
The P2P loan marketplace began in the UK in 2005 with a company called Zopa and expanded to the US in 2006 with the launch of Prosper and Lending Club, which according to Michael Kitces, a respected nationally-renowned financial planner, are the two top P2P lending platforms.* The SEC intervened in 2008 and began to require peer-to-peer companies to register their loans as securities for the investors who funded them (and third parties who wanted to purchase them), and the peer-to-peer lending market has exploded in growth since then.
The biggest difference between peer-to-peer lenders and traditional lenders (including debt consolidation companies) is that the loans are backed by everyday investors. The P2P marketplace operates as an alternative to traditional lenders for consumers looking for small loans at decent interest rates. Investors loan their money and receive interest on their loan; borrowers borrow money, paying interest on the money they borrow. As a result, there are typically less restrictions and barriers to securing a long.
Each state has its own regulations, so borrowing and investing from P2P lenders isn’t allowed in all states. As you can see from the map below, Virginia allows for investors and lenders in both Prosper and Lending Club.*
Both Prosper and Lending Club require borrowers to fill out an online loan application. The application only counts as a “soft” inquiry, so it won’t negatively impact your credit score. If approved, your interest rate will depend on your credit score, loan amount, loan term, and credit usage and history.
P2P Loan Terms*
Use - 83% of Lending Club borrowers use their loans to refinance existing loans or pay off their credit cards, and about 5% use loans for home improvement projects.
Credit Score - The minimum credit score required to qualify for Lending Club is 660, and 640 for Prosper.
Loan Amount - Personal loans start as low as $1,000 and can’t exceed $35,000. For small businesses, loans start at $15,000 and are capped at $35,000 (Prosper) and $100,000 (Lending Club.) Note: Don’t take out a loan for more than what is needed. Like any type of loan, whether it’s from a bank or a P2P lender, falling behind on payments means paying even more over the long term.
Term - Loans are typically issued with three or five-year terms, with monthly payments. I suggest taking out the shortest loan term available; while your monthly payment will be lower with a longer term, you will be paying over a longer time-period, and therefore paying more in interest. Note: Make sure to check whether the provider allows you to pay off your loan early, penalty-free.
Interest Rate - The biggest draw for P2P loans is their interest rates. The interest rates on these loans are typically lower than on credit cards – assuming you have a good credit score. For example, Lending Club’s rates range from 5.32% to 28.99%. The riskier the borrower, the higher the rate.
Fees - All P2P lenders charge a fee. Prosper and Lending Club both charge fees for new loans 1.11% to 5% of the total loan amount at Lending Club, (1% - 5% for Prosper), depending on the size of the loan. The origination fee is included in your APR, and subtracted from your total loan balance before you receive it. Note: If you’re late on payments, fees will increase. Make sure to read the terms carefully.
In closing, P2P loans may be a relatively inexpensive way to tackle consolidating your credit card debt. However, make sure to compare and contrast P2P loans with other options – many credit card lenders have 0% balance transfer offers, and your bank or credit union may also have some competitive debt consolidation options. And if you are interested in becoming a lender/investor, P2P loans may offer an alternative to bonds, which are currently yielding very little given today's low-interest rate environment. Just be aware that the higher the interest rate received, the greater the risk - that is, the higher the probability of the borrower defaulting.
As always, give us a call if you have questions.
* Alexis Advisors, LLC does not endorse any of the providers referenced in this article. Providers discussed are for informational purposes only. The reader should explore various P2P lender/debt consolidation options, and make a choice based on their own research.
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