Peer-to-peer loans catch on for credit card debt consolidation
Their use booms, but know what to expect
More consumers than ever are seeking quick cash from peer-to-peer (P2P) lending sites, the online clearinghouses where people are matched with investors and receive money to pay off debts, start businesses or fund home improvements.
|BOOM IN P2P BORROWING|
Peer-to-peer loans are a small but growing segment of the credit market. Our reports examine whether they're right for you and what alternatives exist.
MAIN STORY: Peer-to-peer loan: right for you?
SIDEBAR: Nontraditional borrowing choices
The two major P2P sites -- Prosper and Lending Club -- are poised to have their biggest year ever. In the first four months of 2013, Lending Club made more than $480 million in loans to more than 31,000 people -- roughly triple its numbers from the same period in 2012. Prosper made more than $50 million in loans in the same period, up about 20 percent compared with last year.
The loans -- which people use for a variety of purposes, ranging from debt consolidation to wedding expenses -- come with a fixed interest rate. As of the end of May, Prosper was advertising rates of between 6.73 percent and 35.36 percent APR.
While the big growth in P2P lending comes from more individuals discovering the benefits of taking out or making these loans, it is also fueled by professional investors and hedge funds, which recently started pouring in big money to fund the loans as they search for alternative investments with solid returns.
"There are now people in the market who have a tremendous amount of knowledge of data, especially credit data," says Peter Renton, who covers the industry on his blog, Lend Academy. "They really believe that there is an advantage to be had by taking on certain segments of loans."
For borrowers who qualify for P2P loans, that new infusion of cash means their loans receive funding more quickly. Once an applicant is approved by Prosper or Lending Club, they typically receive funding within two or three days. In the past the same loans might have languished on the market for much longer -- or not have received funding at all.
Debt consolidation tool
Prosper and Lending Club say they provide consumer loans that traditional banks tend to avoid. They sense a big opportunity among people who have credit cards with high interest rates. More than three-quarters of Lending Club borrowers and half of Prosper borrowers use the money to pay off other debt.
"The message is, there's a new option for people with credit-card debt to pay off and consolidate that debt," says Ron Suber, Prosper's head of global institutional sales. "It's a fixed rate and fixed term, where you know you can be out of debt."
Compared to other major sources of unsecured credit, such as credit cards, peer-to-peer loans often offer more attractive interest rates. In fact, the majority of P2P borrowers use the loans to pay off credit-card debt at a lower rate.
Because of the fees charged to borrowers, P2P loans might not make sense for everybody looking to pay down credit-card debt. If you have the discipline and means to pay off or substantially pay down your debt within a year, finding a credit card that offers 0 percent interest for an introductory period might be a smarter move.
Prosper says 51 percent of its loans go to debt consolidation, more than for any other purpose. The same is true of Lending Club loans, 79 percent of which are used to pay off credit card debt.
For instance, if you're paying down $5,000 in card debt and have generally good credit, a three-year Prosper "B"-rated loan goes for at least 13.59 percent interest a year, which works out to several hundred dollars a year. Plus, there's a 3.95 percent closing fee -- that's another $197.50.
Lots of cards with no annual fees offer introductory 0 percent interest on balance transfers and purchases for six, 12 or even 18 months. But after that period, rates typically zoom to 14 percent or more, and sometimes into the 20+ percent range.
That might sway you toward applying for a P2P loan -- but there's no guarantee you'll be approved. While the application process is simple, peer-to-peer lenders are notoriously selective: Lending Club, for instance, has approved only 12 percent of loan applications since 2007. The companies do not make loans to people with subprime credit (credit scores below 640 at Prosper and 660 at Lending Club).
Credit-card companies do serve those borrowers, albeit with high interest rates and fees, or with a requirement for a security deposit before the card can be used.
Other common uses of the loans include making home improvements, paying for weddings or starting a business. P2P lending has become particularly attractive to small-business owners facing a tight credit market.
Lydia Hamilton-Monnie is a prime example. Despite a credit score around 750 and a steady income as an information technology project manager, she was rejected from three banks when she sought about $50,000 to start a business in late 2009.
While searching for other funding sources on Google, she came across Prosper and Lending Club and decided to apply for $25,000 from each. Within a few weeks, she had the money, which she and her husband pooled with savings to open Boutique Larrieux, a plus-size women's contemporary clothing shop in Milwaukee, Wisc.
Her store and accompanying e-commerce site are doing so well that she repaid both loans early, she says. Each was a three-year loan with an annual interest rate of 11 percent or 12 percent.
She says she thinks investors agreed to lend her money because of her strong credit history and her compelling story, which she shared in her online profile.
"Once you've gone through the peer-to-peer process, I'm like, ‘Why go to a bank ever again?'" she says. "It's so transparent, it's so easy, it's so fast. With the banks, there's just so much red tape."
How it works
To apply, you submit a wealth of information online, such as the amount you're seeking, its intended purpose, the proposed term and so on. The companies then run background checks, including a close examination of credit scores, available credit and recent credit card applications, and they plug those factors into mathematical models that predict whether you will repay the money.
If you pass muster, the companies assign a grade and an interest rate to the proposed loan. If your credit is excellent, you'll likely have a high grade and a low interest rate. At Lending Club, for instance, top-ranked borrowers were paying interest rates of 6.78 percent at the end of May. In contrast, the highest rates -- designed for approved borrowers with the worst credit -- were nearly 28 percent.
After the companies approve a loan, it becomes available for funding from individuals, who can review much of the same material the companies used to approve the loan. Investors typically fund portions of multiple loans to spread their risk. Some seek riskier loans because they pay higher interest rates, while others prefer loans with high grades because they are more likely to be repaid.
The companies make money by collecting fees from both borrowers and lenders. The borrower pays an origination fee of between 2 percent and 5 percent when the loan is made, and the investor pays an annual 1 percent fee.
Be warned: Failing to repay a loan has consequences just as serious as not paying other kinds of debts, says Monica Steinisch, who wrote a report on the P2P industry for the consumer advocacy group Consumer Action.
"This has an informal feeling about it, but you are still entering into a legally binding contract," she says. "If you miss payments, you are going to get calls and letters from a collector. You'll be reported to credit bureaus. It will affect your credit score. You could be sued. Your wages could be garnished."
|OTHER P2P CHOICES|
Lending Club and Prosper are not the only sites to link people who want money with people who have money. Outside of consumer loans, here are other sites that are harnessing technology and upending traditional ways to get cash:
Experts say there are plenty of ways that borrowers can make their applications more attractive to the companies and to the people who fund the loans. The more creditworthy you appear, the lower your interest rate, and the more likely investors will advance you the money you seek.
Here are some tips to improve your chances of getting a P2P loan at the lowest cost to you:
- Provide a detailed description of why you need the money. Although many borrowers bypass the chance to explain why they're seeking a loan, investors like details. Even mentioning a steady income and successful repayment of prior loans can help. Be aware that some investors shy away from funding loans they consider frivolous, such as money for taking vacations.
- Improve your credit. There are no quick fixes, but there are steps you can take to boost your credit score, such as paying bills on time and not signing up for new credit cards before seeking a P2P loan. If your credit is poor, you might not be approved, and if you are, you'll face a higher interest rate than those with better credit.
- Don't seek more money than you need. Bigger loans mean you'll pay higher fees and probably higher interest rates. The maximum you can borrow is $35,000.
- Opt for a shorter term, if you can afford it. Although the monthly payments are higher for shorter-term loans, they also tend to carry lower interest rates. The faster you can repay the loan, the better. There is no penalty for repaying early.
- Avoid late payments. Just like credit card companies, peer-to-peer lenders charge hefty fees for missed payments. The lenders are just as serious as a traditional bank about getting the money they are owed.
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