Should You Cut Your Credit Card Debt With a Peer-to-Peer Loan?
About two in five American families can’t pay their credit card bills, carrying over a median of $3,800 a month, according to a 2015 Pew Charitable Trusts study. Many drag around far more debt than that.
An increasingly popular solution is peer-to-peer lending. Lending Club and Prosper, the two largest peer-to-peer lenders, are online platforms that directly connect debtors with investors. By cutting banks out of the lending process, they claim to offer lower rates and better terms to borrowers.
Both companies are on track to at least double their lending this year from 2014, when Lending Club lent $4.4 billion and Prosper lent $1.6 billion. Their core business is refinancing credit card debt, though they’re branching out into loans for home improvement, surgeries, and even vacations.
Are peer-to-peer lenders the best option for credit card debt?
Prosper and Lending Club do have important advantages. Their online application processes make it easy to quickly pool all your credit card balances in one consolidated loan. Your interest rate is fixed, and payments are spread over three or five years.
But while some borrowers with pristine credit can get rates in the single digits, the average annual percentage rate (APR) of peer-to-peer loans isn’t much lower than a typical credit card's. Such loans also can be a temporary measure that doesn’t fix the underlying problems.
“It is never a good idea to borrow your way out of debt, especially if the debt is already unmanageable,” Bruce McClary, of the National Foundation for Credit Counseling, said.
So what is a good way to get out from under a pile of debt?
Here's how peer-to-peer lending stacks up against more traditional services.
Shopping for teaser rates
Pro: If you shop around, some credit cards may offer you a lower rate than you’d get on a peer-to-peer loan. The average credit card APR is 15 percent, according to CreditCards.com. If you have good credit, you may be offered a card with a teaser rate as low as zero percent.
Prosper charges an average interest rate of 13.4 percent, and its average APR, including fees, is 16.2 percent. Lending Club doesn't disclose its average APR, but its average interest rate is 13.1 percent, and its fees are similar to Lending Club's — a one-time origination fee that is 5 percent for all but the highest-quality borrowers.
Con: There’s often a fee of 3 or 4 percent to transfer funds to a teaser credit card. Also, teaser rates last only for a typical introductory period of 6 or 12 months and then can spike. The payments and rates on peer-to-peer loans are fixed, no matter what happens to interest rates over the next few years.
Some borrowers will have trouble shopping around. They may find they’re stuck with credit cards with APRs of 20 percent or more. For them, peer-to-peer loans are a great option – if they qualify. 1 Both Prosper and Lending Club have strict criteria. Lending Club borrowers must have a minimum FICO credit score of 660 for its standard loans. Prosper requires a minimum FICO score of 640, and accepts only one of nine loan applications. When borrowers go from credit cards to a Lending Club loan, their interest rates drop by a third on average, or by about 7 percentage points.
Pro: Nonprofit credit counseling isn't just for people with huge, unmanageable debt. A credit counselor might enroll you in a debt management plan. These plans don't reduce the total amount you owe, but counselors can negotiate with creditors and slash your interest rates, typically by half. At Cambridge Credit Counseling Corp., the average borrower APR fell from 21.8 percent to 10.6 percent.
Con: Nonprofit credit counselors are often confused with for-profit debt settlement firms. Consumers should ask about counselors’ accreditations and make sure they’re charging reasonable fees on a debt management plan. The average monthly fee at the nonprofit GreenPath Debt Solutions is $36.
Debt management plans aren't for the faint of heart. If you enroll, you typically need to cut up all your credit cards, stick to a budget, and refrain from taking out any new debt for a few years. It’s designed to be a more comprehensive solution for chronically indebted people than just taking out another loan. “It’s more than just paying back your debt,” said Kathryn Bossler, a counselor at GreenPath in Detroit. “It’s a different way of thinking about debt in general.”
Closing down credit card accounts may hurt your credit score a bit, at least initially. In a peer-to-peer loan, by contrast, you can keep all your accounts open after you pay them off. That may actually increase your credit score, by moving debt from revolving credit cards to an installment loan. Of course, you may be tempted to rack up debt all over again.
Pro: If a credit card company fears you can’t pay back your debts, it may be willing to accept partial repayment. Consumers can hire debt settlement companies to help negotiate with creditors, but these firms can be expensive and aren’t always effective. (The American Fair Credit Council, a group of debt settlement companies that call themselves the "watchdogs" of the industry, lists accredited member companies that agree to ethical standards and yearly audits.) You can avoid the fees by calling up the credit card companies yourself.
Con: Typically, credit card companies negotiate only if you have the cash to settle at least some of your debts immediately. Charging off debt with a settlement can also be disastrous for your credit score. Finally, the fees at debt settlement companies can be confusing and complicated. Prosper and Lending Club pride themselves on a straightforward fee structure: Borrowers on both platforms pay an up-front fee of up to 5 percent of the loan.
Pro: Bankruptcy gives debtors a fresh start. It’s a comprehensive solution when your debt has grown so large you can't pay it off. State bankruptcy rules often shield debtors’ homes from creditors, and federal law generally protects retirement accounts.
Con: Creditors will ostracize a bankrupt consumer, making it impossible – or a lot more expensive – to get a mortgage or car loan for as long as a decade. A bankruptcy is a matter of public record, and it still holds a stigma for many Americans and even for potential employers. Student loans usually can’t be discharged in bankruptcy.
People who qualify for Prosper or Lending Club are unlikely to be desperate enough to consider bankruptcy. They mostly want to simplify their debt, not wipe it out. “These are people who are employed," said Lending Club Chief Operating Officer Scott Sanborn. "They’ve got an income stream," and their debt load is manageable.
Other kinds of loans
Pro: People can pay off credit cards with personal bank loans and home equity loans and by borrowing against their 401(k) retirement accounts. Through these methods, they’ll often borrow at much lower rates than through a credit card or peer-to-peer lender.
Con: Borrowers get low rates because they’ve put up collateral. That makes these kinds of debts risky. If you can’t pay back a home equity or 401(k) loan, you endanger your house or your retirement.