More take social lending route to consolidate debt

Shedding credit card debt is most common cause for 'social' borrowing

Editor's note: See more recent story, "Peer-to-peer loans catch on to consolidate card debt"

If you're mired in credit card debt, the credit squeeze hasn't done you any favors. Not only is it tougher to get new lines of credit, but banks also are more reluctant to finance debt with fixed-rate loans.

While using traditional methods to paying off debt may be more difficult than in the past, some are looking at a new way to pay off their credit card bills: social lending. Through sites such as Prosper, Lending Club, and Zopa, many people who may not have qualified for (or couldn't afford) traditional bank loans are getting fixed-rate loans through social lending, also known as peer-to-peer lending. "In a very broad sense," says Roy Wiggins III, a finance professor at Bentley College in Waltham, Mass., "it's a way of managing lending and borrowing without a financial intermediary, like a bank. It's more direct."

Here's how it works: Borrowers create online profiles of themselves and share a range of verifiable financial and personal information with social lending sites. Lenders read through profiles and help fund the loan in increments of $50 or more -- with the promise of higher returns than traditional CDs or money market accounts. The sites combine dozens of small lender offers and package them into a single fixed-rate loan, which borrowers pay off through automatic bank payments (usually over the course of three to five years). Additional costs, such as origination fees, are generally rolled into the loan itself.

The idea of social lending has been around for some time, but it's only been in the past few years that technology has caught up. Because of the much lower costs and greater availability of electronic payments, social lending has become more readily available to a greater number of people.

Though these types of loans have been used for funding anything from entrepreneurial ventures to wedding expenses, people have been flocking to the sites to get cash to pay off their credit card bills. At Prosper, for example, about half of all funded loans are used for debt consolidation and paying off high-interest debt. Zopa CEO Doug Dolton reports that debt consolidation is the leading reason that prospective borrowers request Zopa loans.

About half of all funded loans are used for debt consolidation and paying off high-interest debt.

-- Chris Larsen, CEO

Prosper CEO Chris Larsen says the simple structure and fixed-rate loan can be appealing to those working to pay off credit card debt. "It can help people get disciplined schedule to get that debt whittled away," he says.

Evangelina Mirano, 42, says that it's working for her. The Miami resident got a $13,000 loan from Prosper this past March to help pay off two credit cards that had interest rates of more than 15 percent. Through Prosper, she was able to get a three-year loan with a rate of less than 8 percent. She says the regular, automatic payments have helped her get back on track. "It's a sigh of relief to me, knowing that I'll be done with this debt in a couple of years," she says.

Though the lending process may have an informal feel, the standards are just as tough as those you'd find from traditional lenders, says Dolton. "We're a responsible lender," he says. "We report delinquent borrowers to the credit bureaus." Delinquent borrowers may also face collections agencies if they don't pay up."

Wiggins says that while social lending is a useful new tool, borrowers should be committed to changing their ways before they take on any loan. "You don't want to look at social lending as a panacea," he says. "If the problem you have is your spending habits, and you just use something like this so you can go back to the store and keep spending, you're just putting off the inevitable day or reckoning.

See related: Pros and cons of using social lending, Balance transfer cards, 5 steps to eliminate credit card debt, Credit card debt consolidation, Tips for dealing with debt collectors

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Updated: 11-22-2017