Carrying high-interest credit card debt? If you've got good credit and a steady income, you might be able to refinance through peer-to-peer lending.
In peer-to-peer lending, consumers apply for and receive loans from other consumers via social lending companies that take online loan applications, do credit checks, approve or deny the applications, and service the loans.
The largest U.S. peer lending company, Lending Club, made about $2 billion in loans in 2013. Prosper, the second largest, made almost $360 million in loans last year. Loan amounts typically range from $1,000 to $35,000, depending on the company, with terms of three to five years.
For consumers who can get a lower interest rate than they're currently paying on their credit card and can pay off the loan within the timeframes offered, peer-to-peer lending can be a good choice, says Linda Sherry, director of national priorities for Consumer Action.
“In today's world, there just aren't that many options for refinancing existing credit card debt,” Sherry says.
How does P2P lending work?
Here's the typical process for getting a peer-to-peer loan, sometimes known as a P2P loan, though it can vary by company:
- You fill out an online application with some basic information about yourself, including the loan amount, why you want it and your assessment of your credit.
- The company does a “soft pull” on your credit, meaning they peek at your credit history in a way that doesn't ding your credit score. You find out instantly if you're a candidate for a loan, and your options for APR and terms. If you get a loan, you'll pay an origination fee, typically up to 5 percent, which is taken out of the loan before you get the money. So, according to Consumer Action, you should make sure to take that fee into account when deciding how much to request.
- Your loan request is posted online for investors to see. With Lending Club, Prosper and Peerform, another peer-to-peer lending company, the investors do not see your name or identifying information, but can see everything else, such as your income, reason for seeking a loan, credit history and amount of current debt. Investors can choose to fund part or all of your loan, and most loans are funded by many investors.
- In the meantime, the company verifies your identity, makes an official inquiry on your credit — which can affect your score — and asks you for more documentation, which might include bank account information, tax records and pay stubs.
- Within about a week, the company decides whether to approve your loan. If they do, the money is deposited into your bank account. Although the loan was already posted, the lenders simply don't pay if the loan isn't approved.
- You pay a set amount each month, typically through automatic debit from your bank account, though some companies accept checks.
The pluses and minuses of peer-to-peer loans
For the right consumer, peer-to-peer loans can work well. There are several advantages to P2P loans, experts say:
- You might get a low interest rate. The lowest interest rate offered by Lending Club to the top-rated borrowers is 6.03 percent (6.78 or 7.30 percent APR, depending on the term, when you factor the origination fee into the cost of the loan). However, many borrowers don't qualify for that rate: The highest interest rate for the riskiest borrowers is 26.06 percent (28.69 or 29.99 percent APR).
- You know when you'll be debt free. Peer-to-peer lending can help consumers tempted to just make the minimum payment on their credit cards, experts say. With a peer-to-peer loan, you make set payments and, at the end of the term, are debt-free. “You don't get in any minimum monthly payment trap,” says Scott Sanborn, chief operating officer of Lending Club.
- No interest rate surprises. Unlike credit cards, which can trip up consumers with rate fluctuations and penalty rates, the interest rate on a peer-to-peer loan is fixed and relatively straightforward.
- You borrow mostly from other consumers. You're borrowing from “peers,” who range from regular folks investing part of their savings to multi-millionaires working with their investment advisers. However, some banks have invested in peer-to-peer lending. Some borrowers like “knowing there's a person lending them money and getting some yield on their cash,” says Ron Suber, Prosper's head of global institutional sales.
However, there are several downsides to these types of loans:
- It can be extremely difficult to get a loan. To get a peer loan, you must have decent to excellent credit. The minimum FICO score to get a loan through Lending Club is 660 and 640 through Prosper, and your score is no guarantee you'll qualify. “We're a prime and near-prime lending marketplace,” says Suber. The company nixes about 85 percent of prospective borrowers, he says, either because they don't qualify or fail to submit required documents. Most of the consumer complaints about peer-to-peer lending in online reviews are from those who got rejected. One consumer with a FICO score of 698 complained he got turned down by Peerform due to high debt-to-income ratio, “which is why I wanted to consolidate existing debt,” he wrote.
- Consumers in certain states can't use P2P lending. Iowa, Maine and North Dakota do not allow peer lending, according to a Consumer Action report on peer-to-peer lending. Also, laws in other states vary, and not all peer-to-peer lending companies make loans in all states.
- You have to pay fees. Lending Club, for example, charges a loan origination fee of 1.11 and 5 percent, depending on your credit rating, and Prosper charges a closing fee of 2 to 5 percent. The fee is taken off the top of the loan amount. Other fees charged by Lending Club: a $15 fee if the payment is rejected by your bank due to insufficient funds in your account, a $15 fee for paying by check and a late fee of $15 or 5 percent of the payment amount (whichever is greater). Prosper charges similar rejected payment and late fees.
- Not all companies report to the credit bureaus. If you reduce your debt by using a peer-to-peer loan, that will give your credit score a boost. However, it's a good idea to check to make sure the lender reports on-time payments to the credit bureaus, if you're counting on that to help improve your credit, too. Both Lending Club and Prosper say they report. However, not all peer-to-peer lenders do, according to John Ulzheimer, a credit expert with CreditSesame.com. “So, if credit building or rebuilding is needed, you may not get any value from a P2P loan,” he says.