Peer To Peer Lending -- Great Idea or Major Pitfall?
We're back from a long hiatus. We've seen the usual in the past few months: sources conflicting on whether foreclosures are up or down; the return of zombie proerties just in time for Halloween; and more reports that show our federal regulators dropped the ball on the National Mortage Settlement and the Independent Foreclosure review.
However, since then, I've been receiving letters from a couple of new peer to peer lending platforms. There's even been a post at Huffington Post about the new trend. Peer to peer lending is not like debt consolidation or debt settlement because you can, in theory, take out a loan for any purpose. That said, it would appear that the majority of people use peer to peer lending to resolve credit card balances.
Peer to peer lending is being described as a sea change in the lending industry. I remain skeptical. Here's the process, according to the Huffington Post article listed above.
1. Pick a lending website. There are a few. They are linked by HuffPo and, given that I am skeptical, I won't link them here.
2. Request funds. State purpose.
3. Submit info. There is a soft credit pull. This is the kind of pull that does not adversely hit your score.
4. Get offers. Interest rates vary from 6% to 25% or higher. Loan terms are generally 3 to 5 years. The minimum credit score appears to be 640.
5. Submit any additional forms.
6. Get money.
7. Use money.
8. Begin repaying new loan.
So how is this better than consolidation? With debt consolidation, some companies collect funds from you and then remit them to lenders. Sometimes those payments aren't particularly effective at paying down principal and interest.
With peer to peer lending, in theory, you'd receive one lump sum in cash. With that cash, you'd pay off your credit cards. This could be beneficial to your credit score. Here's how:
Let's say that you owe $7,000 across two credit cards. Your total credit limit is $7500.00. Both cards have interest rates at around 19%. You pay $100/month on each card. This will not pay them off in a very timely fashion, but exceeds the monthly minimum payment, so some principal is being paid down.
You take out a peer to peer loan for $7.000.00. You use it to pay off your credit cards. You get a loan at 10% interest, which is a much better rate than your credit cards. You also just increased your total credit limit from $7,500.00 to $14,500.00. You went from almost 100% utilization to less than 50% utilization.
This should help your credit score because the ratio of available credit to used credit is a key factor in calculating your score.
Most of these loans have no prepayment penalty, which is nice.
My concern is that I haven't yet vetted the fine print on a peer to peer loan. They are so new that I can't find enough useful data to form an opinion. I may, with the aid of a friend in the financial sector, apply for one and see what happens. In a worst-case scenario, I get offered a stinker of a loan and refuse to take it.
In a best-case scenario, I manage to bump up my score without taking out ANOTHER credit card (this would also improve my credit use ratio, but would allow me to spend more money).
If I do engage in this experiment, then I'll be sure to write about it here.