Should You Consolidate Your Debt Using Peer-to-Peer Lending?
In the world of debt consolidation, there are plenty of people looking to make a buck off of consumer desperation. Being deep in credit card debt can make people feel helpless, as minimum payments don't pay down principal, and interest piles on and on, seemingly without end. Who knew that the Internet would provide one of the best outlets for your desperation? Isn't the Internet just full of liars, scam artists and parody Twitter accounts?
Yes and no. Peer-to-peer lending is one of the few respites for those deep in credit card debt -- it can actually be an effective and transparent way for you to pay down your debts, at reasonable rates.
Take the case of Tammy, a single mother living in Santa Cruz who spoke to MyBankTracker about her experience using a LendingClub loan to consolidate her credit card debt. Tammy was living on one income with children to raise, and no child support -- nothing. So she used credit cards for school clothes and supplies, and other purchases, and even sometimes for groceries. "I used them for whatever I could," she said. She had to in order to make ends meet, but she was responsible with them even as she plunged herself into debt. She kept up on minimum payments on all of her cards, and has kept her credit score in relatively good standing as a result -- Tammy told MyBankTracker she has a credit score of 720 despite her mountain of debt.
As a brief aside, let us point out how important it is keep current on your payments even if you cannot control them. A full 35 percent of your FICO score is based on your payment history and minimum payments are typically low. Even if paying off your debts becomes hopeless, making your payments on time will keep this part of your credit score unaffected, and even if minimum payments hardly even nibble away at the principal, you're avoiding painful late fees and penalty APRs, which can plunge you deeper in debt. We have a natural aversion to doing these sort of things, but they're very important. Spoiler alert: this helped Tammy out in the end.
After a few years of this debt-enabled spending passed, Tammy turned around and realized she was tens of thousands of dollars in the hole and it was not how she wanted to live. So she worked toward paying her cards off, one by one, keeping up with minimum payments on the others in the mean time. She was down to about $30,000 in debt when she decided she wanted to consolidate her loans and live debt-free. Her various credit cards had APRs ranging from 12.9% all the way up to 27.9%. She went to two local credit unions she had relationships with. Would they give her a loan to consolidate her debt? No and no. Too much debt. How about her bank? Definitely not.
In the meantime, she got a piece of what she assumed was junk mail from LendingClub. Well, it's all junk mail until it turns out you happen to need it, and such was the case for Tammy. She eventually got curious and checked out the peer-to-peer lending site in the early morning hours, before work and before the kids got up, and found what she was looking for: a way to consolidate her debts, and get her out of debt quickly. She applied for, and was approved for, a $25,000 loan via LendingClub, with a 36-month term and an 8.33% APR.
The power of crowds
Quickly, 188 different investors started lending various amounts of money to Tammy. It was fun to watch: "I would go into my account and watch people contribute to my loan." After a week, the money had been raised. Tammy turned around and paid off all her cards (she had $5,000 on zero-APR cards, so she only borrowed the $25,000 for her $30,000 debt). She seems totally, unabashedly enthusiastic about the service, which she describes as "awesome" or "cool" -- we might stop short of those descriptors, but it's certainly better than several credit cards.
What is definitely cool about P2P lending is the way it makes lending to the Tammys of the world possible. Whereas her bank and credit union simply couldn't take on that sort of risk, 188 investors could spread it amongst themselves, investing as little as $25 each. These investors might diversify a $1,000 investment across 20 different loans, all with different risk profiles. By spreading the risk among a pool of investors, riskier, larger loans can be compiled to serve customers that banks might not be interested in.
That could be why approximately three-quarters of LendingClub borrowers use the service to consolidate debt. Not everyone gets as good a rate as Tammy did, and experiences likely vary. LendingClub rates can go as high as 26.99%. Prosper, its competitor, has rates as high as 35.84% -- which is substantially higher than most credit cards' penalty APR. Using P2P lending for debt consolidation isn't for everyone, to be sure. But it's an interesting new way to harness the power of the crowd.
It can also be an interesting way to invest.