Should You Use Peer-to-Peer Lending to Pay Down Credit Card Debt?
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If you are digging yourself out of credit card debt, you might consider borrowing from a peer-to-peer lending (P2P) company. Depending on your personal situation and credit profile, this approach may enable you to get out of debt faster and save money.
There is much to consider besides the possibility of snagging a lower interest rate, reducing your monthly payments, and accelerating your payoff. Here's what you should know about getting a loan from Peer-to-Peer lender.
Consider the Pros and Cons of Peer-to-Peer Lending
Getting a P2P loan has several benefits that may allow you to quickly pay off credit card debt.
Lower Interest Rates
Interest rates as low as 6.03% are available through P2P lenders, depending on your creditworthiness. Even if you don't qualify for the lowest possible rate, you may be able to borrow at rates much lower than the current rate on your credit card, which could be as high as 30%. Additionally, credit cards are set up so that you're paying interest on top of your interest, since it's based on your running total balance.
Fixed Payment Schedule
Loans are fully amortized over standard loan terms of either 36 months or 60 months and your interest rate stays the same throughout the term; as a result, your loan payment is predictable and each loan is paid in full at the end of its term.
Before committing to a new loan, be sure that you are aware of all the costs, including the monthly amount due and additional fees.
Loan origination fees are charged to borrowers at both Lending Club and Prosper. These fees range from 1.1% to 5.0% of the loan amount and are deducted from loan proceeds transferred to the borrower. The annual percentage rate (APR) associated with the interest rate offered to you reflects the true cost of borrowing and includes the origination fee (similar to credit card companies' balance transfer fees).
Fixed Monthly Payment
Borrowers must make the entire loan payment every month, as opposed to a credit card balance where you can change your payment depending on your cash flow (after meeting the minimum payment required).
Late payment fees are the greater of $15 or 5% of the unpaid loan balance (also referred to as the unpaid installment amount). If you have a high loan balance, 5% could mean a very hefty fee (5% of $5000 is $250).
Compare Total Payments of Various Payoff Alternatives
To decide if you should use P2P lending to pay down credit card debt, start by getting a rate quote. Then evaluate the offers to see what might work best for your situation.
Let's say you have a $35,000 balance on your credit card, an interest rate of 18.90%, and a minimum monthly payment of 4% of your outstanding balance (currently, $1,400.00). If you made the minimum payment of 4.0% for five years and then $500 per month until the balance was paid down (with the last payment to wipe out remaining debt), then you would pay $52,615.70 over 78 months.
Borrowing through a P2P lender to eliminate the credit card balance and then repaying the P2P loan may work better for you financially. For example, you could take out a debt consolidation loan at Prosper. Judging from listings on the firm's website, you may be able to snag a 36-month loan at an interest rate at 10.29% for a monthly payment of $1,134.12 if you have good credit with an "A" rating. You would be charged a loan origination fee of $1,400.00. Over the life of the loan, your cost to destroy your credit card debt using this method will total $42,228.42, as long as you made every payment on time and never had a late fee or other charge.
Alternatively, you could borrow money through Lending Club. Based on a rate offered to a family member, you may be able to get a 36-month loan for a credit card payoff at an interest rate of 7.69% if you have average credit with an "A4" rating. Your loan origination fee would be $1,050.00 and your monthly payments would equal $1091.78. In total, you would make payments of $40,354.24 to pay off your loans.
If you decided to aggressively pay down debt with $1,400.00 monthly payments, then the credit card balance would be eliminated in less than three years using any of these options. Your total cost would vary from just over $39,000 to nearly $44,000 depending on interest charges and loan origination fees.
Note that if your credit card rate is much higher, 29.99% for example, then the benefits of a P2P loan are significantly greater.
Be Realistic About Your Cash Flow
Crunching the numbers to determine your best course of action is a reasonable way to make a decision. In the scenario described above, paying off your credit card balance at a high rate and borrowing at a much lower rate using a P2P loan seems to make the most sense.
But before signing up to get a debt consolidation loan, you should consider what might happen if you are late in making a payment. At both Lending Club and Prosper, late payment fees are the greater of $15 or 5% of the unpaid balance. So, if you happen to have a cash flow problem in the second year of your loan and are more than 16 days late on a payment, you'll be charged a late fee of more than $1,000. Just a handful of such fees can create significant loan-payoff woes.
A comparable problem with your credit card company may trigger late fees and added interest charges (along with a higher interest rate), but the cost of your tardiness should be less than the P2P fees. Again, every situation is different and should be evaluated independently.
If your financial picture is likely to change in the next three to five years, consider whether your cash flow will be able to sustain regular payments. Major life events, such as returning to graduate school, starting a family, or opening a new business, may interfere temporarily with the availability of funds. Make sure you will be able to make the monthly payments on a timely basis over the life of the loan.
When comparing various types of credit, look at all aspects of the loan structure, interest rate, monthly payments, terms, and fees. Note that offers extended to you may look much different than those available to your friends, coworkers, or family members. Do the math and consider your entire financial picture when determining whether you should use P2P lending to pay down credit card debt.