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P2P lending

If your credit card debt is out of control, you might consider consolidating. Credit card consolidation is taking out a loan, usually with better terms, to pay off several credit card debts. One way to consolidate is taking out a loan using peer-to-peer or marketplace lending.

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What is P2P lending?

P2P lending is peer-to-peer lending — when an investor will lend a borrower money with an agreed-upon monthly payment and interest rate. The two biggest P2P lenders are Prosper and Lending Club. This type of lending is also known as marketplace lending. Lending Club offers unsecured loans up to $40,000 and Prosper offers loans up to $35,000, for a variety of purposes, including consolidating your credit cards.

After obtaining a loan, you can set up automatic payments or manually pay each month. What’s the motivation to pay off your loan if it isn’t through a bank? Like traditional loans, non-payment or default on P2P loans is reported to the credit bureaus and can damage your credit score.

Lenders invest in P2P loans because they can generate a decent return while helping their peers obtain loans at reasonable rates. While lenders do incur the risk that borrowers will default on their loans, this can be mitigated by choosing borrowers with strong credit profiles. Most lenders lend in small increments, like $25 or $50, so your loan may be funded by a multitude of lenders, lessening their risk even more through diversification.

at Lending Club

at Prosper

Can I use P2P lending programs?

An eligible borrower must be a U.S. citizen or permanent resident, at least 18 years old and have a bank account. Prosper specifies that a borrower’s credit score must exceed 640. Lending Club requires a minimum score of 600. Your income stability and the amount of debt you have in relation to your income will also determine your eligibility.

Also, there are some state restrictions on borrowing with or investing in Lending Club and Prosper. Because we’re only focusing on borrowing to consolidate your credit card debt, we’ll just examine limitations for that type of loan.

As of October 2016, Prosper can’t accept loan applications from residents of Iowa, Maine, North Dakota, Pennsylvania and West Virginia and Lending Club can’t accept loan applications from residents of Iowa and West Virginia.

If you live in these states, consolidating your credit card debt with a P2P loan is not an option at this time. However, there are other consolidation options, such as 0% interest rate cards, regular personal loans or possibly a HELOC.

Why should I consolidate my credit card debt with a P2P loan?

  • It’s cheaper than using credit cards. If you have a good to excellent credit score, you may be able to get a much lower P2P rate than you’re paying on your credit cards.

    Borrowers are given letter ratings according to their credit scores, typically ranging from A or AA to G or HR. The closer to A or AA, the better the credit scores. Those borrowers with A or B ratings will pay APRs between 6.73% and 17.20%, much less than the average credit card interest rate of 21% as of April 2014. Of course, those with low credit scores may pay much more than 21%.

  • You’re a desirable loan candidate. If you have a low credit score, high debt and low income, you likely won’t be a lender’s first choice. While some lenders are willing to take the risk in order to get the higher returns, most lenders are looking for moderately safe borrowers. If this is you, a P2P loan may be the way to go.

    It also doesn’t hurt to come across as professional and responsible. When applying for your loan, treat it like any other loan, and present yourself competently with correct grammar and spelling. Keep your tone polite and reserved, instead of desperate and frazzled.

  • You have a debt payoff plan. Unlike credit card debt, loans generally have a specific end date. In other words, your minimum payments are designed to pay off the entirety of your loan in a certain amount of time. For P2P loans, this timeframe is typically two to five years.

    You need to make sure you can afford to make this monthly payment, as it will assuredly be greater than your former credit card minimum payment. Understand how much interest you’ll be paying and if possible, make additional payments to shave time and interest off your loan provided it makes sense for your financial plan.

» MORE: How to pay off debt

Why shouldn’t I consolidate my credit card debt with a P2P loan?

  • Your credit card interest rate is lower than P2P rates. Particularly if you have a low credit score, you may find that your credit card APR is lower than the P2P options. In this case, you’ll want to either find an alternate way to consolidate your credit card debt or pay it off as is.

  • The fees don’t make sense for you, financially. Prosper and Lending Club have origination fees for borrowing ranging from 1-6%. Don’t forget to factor these in when considering whether a P2P loan would be cheaper than keeping credit card debt.

  • You’re moving your debt, but not dealing with it. If you think you’re making progress by simply moving your debt to a different type of account, the problem is bigger than credit card vs. P2P. If you’re consolidating your debt, it needs to be part of a plan to pay off debt, not simply reassigning it to another location. Develop a plan to pay off debt and consolidate only if it assists your plan in a meaningful way.

If you want to explore consolidation via a P2P loan, read NerdWallet’s Prosper review and Lending Club review.

Lending and borrowing image via Shutterstock

This post has been updated. It was originally published on May 13, 2014.