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Peer-to-Peer Loans: A Path to Lower Interest Rates

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author photo by Russ Heaps January 2015

Peer-to-peer (P2P) loans may provide an avenue to consolidating bills, refinancing a car loan or paying off an old debt at a lower interest rate and with less hassle than with traditional lenders. That's right, there's an alternative borrowing method that, in essence, bypasses banks, credit unions, finance companies and other traditional lenders. It's alive and thriving online as part of today's sharing economy.

Several P2P lending websites can be found online by simply typing "peer-to-peer loans" into your browser's search engine.

What Is a P2P Lender?

Not so much a lender as a matchmaker, a P2P platform partners creditworthy borrowers with one or more individuals who have money to invest in their loans. Basically, it involves ordinary people investing in other ordinary people through an Internet site.

Loan amounts tend to be smaller and shorter term. Many are under $10,000, and they rarely exceed $35,000, with terms starting at 2 to 3 years.

A loan can be for almost anything, including home improvements, bill consolidation, education or refinancing.

Interest rates tend to be lower than with traditional lenders because P2P loan services are streamlined, requiring fewer facilities and staff. Many have replaced loan officers with software to determine loan approvals and set interest rates. Interest rates begin in the 5.5- to 6.5-percent range and go up from there.

How Does It Work?

When potential borrows go to one of the P2P websites, they'll fill out an online application. That information is then quickly evaluated. Some P2P sites, such as Lending Club, the largest P2P platform, promise that their evaluations won't impact an applicant's credit score.

Borrowers who are approved are presented with their interest rate as well as a choice of terms. Once the borrower settles on the offer, the loan is presented to registered investors who can supply as little as $25 toward the total loan amount. When investors have fully funded the loan, it is deposited directly into the borrower's bank account.

What Are the Benefits?

Beyond being able to avoid the delays and red tape that can come with dealing with a bank or other traditional lender, the biggest benefit is a more favorable interest rate. A P2P loan isn't a magic bullet for borrowers already in credit trouble or with a shaky credit history. For instance, successful borrowers through Lending Club have had average credit scores over 700.

Given that the primary advantage is a lower interest rate, many P2P transactions involve paying off or consolidating high-interest-rate credit cards or loans. Lending Club claims an average interest-rate savings of about 30 percent for its borrowers, from about a 21-percent interest rate for their outstanding debt to roughly 15 percent for the P2P loan replacing it. Such interest savings can go a long way in helping consumers get a handle on their credit by paying off balances more quickly.

What's the Downside?

There really isn't a downside for the borrower. A few states don't allow residents to participate; otherwise, there aren't any special risks to borrowers. However, there is a small added expense of a one-time origination fee. These fees typically run between 2 and 5 percent of the loan amount. There may also be other fees typically associated with loans, such as late-payment fees.

What it means to you: If you are saddled with high-interest credit card or loan debt, peer-to-peer loans could provide a way out.

This image is a stock photo and is not an exact representation of any vehicle offered for sale. Advertised vehicles of this model may have styling, trim levels, colors and optional equipment that differ from the stock photo.
Peer-to-Peer Loans: A Path to Lower Interest Rates - Autotrader