P2P Loan to Pay Debt?

Dec 5, 2014 by

I’ve got a guest post for you today, a thought-provoking piece by Joseph Hogue, CFA, on using a peer-to-peer lending service to borrow money you then use to pay off high(er)-interest debt. Let Joseph and I know what you think of the idea please! – Kurt

Using Peer Loans to Pay Off High-Interest Debt

p2p online loansOne of the smartest pieces of financial advice I ever heard was, “You can’t borrow your way out of debt.” The guidance was given to me while at a tenth-grade assembly on managing money as an adult. I have lived by the wisdom, and think I’ve done pretty well, never digging myself too deep into debt. But recently I’ve begun to wonder if the saying is not overly simplistic.

Can you borrow your way out of debt?

Peer lending is emerging as a viable source of credit for many Americans, many of whom are locked out by overly strict banking standards more than five years after the financial crisis. Peer lending borrowers fill out an application on one of the two lending platforms, Prosper or Lending Club. Once their application is verified, the loan goes online and investors decide to fund it with $25 or more from their account. The lending platforms collect payments from borrowers and pass the money through to investors.

With 77% of the open loan applications on Prosper designated as debt consolidation, the peer lending revolution may be proving that you can borrow your way out of debt.

Lower Rates…Maybe

Ever wonder why so many credit card companies are headquartered in Delaware or South Dakota? It’s because some states have relaxed usury laws that limit interest rates. Even if you’re rate starts out low during a trial period, there is little keeping the company from increasing it, especially if you miss a payment.

The average rate for an AA-rated borrower on Prosper—the highest rating for credit worthiness—is 7.2% while the average rate for the most risky borrowers is just under thirty percent. While you may not be able to get the best rates offered, it’s also likely that you won’t have to pay the worst rates either.

On an annual rate of 24%, it would take you five years at payments of $282 a month to pay off a $10,000 credit card balance. You would pay $6,920 in interest and that is if you diligently made payments and didn’t add any spending to the balance. Consolidating that debt into a $10,000 peer loan at the average rate of 13% on all loans means you could cut your payments to $225 a month. You would save $3,420 in interest payments or you could pay the loan off in three years and eight months if you made the $282 per month payments.

Fixed Rates and Fixed Terms

One of the best reasons justifying a debt consolidation loan in peer lending is because you can refinance your bills into a fixed rate and with fixed terms. Credit card companies generally reserve the right to increase your rate for a number of reasons. Miss a payment and your rate could skyrocket past the initial teaser rate. Miss a payment on a peer loan and you will pay a late fee of $15 or 5% of the payment, but your rate will not increase.

Peer loans are also for a fixed time period, either three or five years, unlike credit card balances that never seem to get paid off. When you accept the rate on a peer loan and set your term, you will be given a monthly payment amount that will have the loan paid in full over either 36 or 60 months. Instead of paying off loans into infinity, you will actually be able to see the light at the end of the tunnel.

While there are reasons that consolidating your debt into a peer loan makes sense, there are also some risks you need to avoid. Peer loans should never be used as another source of easy cash to spend. It does no good to pay off your high-interest credit cards with a peer loan if you are just going to turn around and max out your cards again. You also need to understand that defaulting on your peer loan will hurt your credit score just as badly as defaulting on any other loan and it will make it much harder to get any more peer loans in the future.

Credit can be a great tool if used correctly but it is not without risks. While not trying to borrow your way out of debt is a good standard to follow, it isn’t the only rule, and peer loans can offer a great opportunity to lower the amount of interest you’re paying. Just remember to use peer loans responsibly like you would any debt, and you could find yourself changing the way you think about borrowing.

Read more from Joseph at his Good Debt, Bad Debt Blog, part of his site Peerloansonline.com. Joseph describes his site as: “Your first stop into the world of peer lending. Whether a borrower or an investor, you’ll find everything you need to make your experience a success along with tips on personal finance and managing debt.”

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