When you take out a loan to consolidate your debt, you can combine several debt payments into one monthly loan payment.
One strategy you can use to consolidate your debts is peer-to-peer lending.
In this article, we’ll look at peer-to-peer lending, how it works, when it would be appropriate to use it, and whether you should consider using it to consolidate your debt.
What is peer-to-peer (P2P) lending?
Peer-to-peer (P2P) lending enables individuals to lend funds directly to borrowers, bypassing the need for intermediaries such as banks. This enables borrowers to obtain funding without the inconveniences associated with conventional financing sources, including building societies and banks.
This direct approach enables lenders to obtain a higher interest rate while consumers pay a lower one due to the reduced overhead expenses of the P2P platform in comparison to a bank.
In addition to benefiting from principal and interest payments, investors assist others in attaining their objectives.
Flexible loans with competitive interest rates are advantageous to borrowers because they are frequently used to finance:
- home improvements
- vehicle purchases
- or the consolidation of more expensive debt
How does peer-to-peer lending work?
The process of peer-to-peer lending is quite simple. Every transaction is completed using a dedicated online platform.
The general P2P lending procedure is outlined in the steps below:
- A prospective borrower (applicant) who wants to use the peer-to-peer lending network submits an online application.
- The platform evaluates the application and the applicant’s credit score and risk level. After that, the right interest rate is assigned to the application.
- Following application approval, the investor (lender) provides the applicant with options that meet his credit score and interest rate requirements.
- The investor has the ability to assess the recommended options and select one.
- The applicant bears the responsibility of making regular interest payments, often on a monthly basis, and repaying the principal amount upon maturity.
What is the average interest rate on peer-to-peer lending?
There is no cut-and-dry benchmark when it comes to interest rates charged on peer-to-peer lending.
Different platforms charge different interest rates, ranging from as low as 6% to as high as 36%. Interest rates are also based on the risk assessment of the borrower in terms of their credit score.
Many lenders impose origination fees between 1% and 8% of the loan amount, plus other administrative costs that add to the costs of borrowing.
When are P2P loans appropriate?
Apart from debt consolidation, here are some scenarios where you may find using P2P lending appropriate.
Personal loans
P2P loans are flexible and can be used for a range of individual needs, including holidays, home renovations, medical expenses, and educational pursuits. P2P lending can be a good choice if you need money for a particular project or event and would rather have a fixed-rate loan with a set payback schedule.
Business loans
P2P loans are a resource that entrepreneurs and small business owners can use to finance their projects. When traditional business loans are hard to come by or have bad terms, these loans can be especially helpful. P2P financing could offer competitive interest rates along with the required capital.
Emergency expenses
Unexpected costs, such as medical bills or home repairs, can make things difficult financially. P2P loans can assist with these costs, enabling you to gradually pay for operations, treatments, and other medical requirements.
Credit building
Successfully repaying a P2P loan may have a positive effect on your credit if you have a limited credit history or are in the process of establishing a credit history.
Some peer-to-peer lending platforms take into account factors beyond a credit score, which can be advantageous for individuals attempting to establish or restore credit.
Refinancing existing loans
If your circumstances have improved after taking out the initial loan, you can refinance it to get better terms or lower interest rates.
When P2P lending may not be suitable
Low credit score
You might not be able to get a P2P loan with a good interest rate if your credit score is low. This situation may result in higher interest costs for you, making P2P lending a less economical choice.
High fees
P2P lending platforms charge various fees, including origination fees. You should consider these fees and factor them into the overall cost of the loan.
Loan limits
P2P loans typically have limits on the amount that can be lent. If your debt consolidation needs exceed these limits, P2P lending may not be a practical solution.
Risk tolerance
There is a possibility that investors will not provide the full funding for your loan or that you will be unable to locate a suitable loan on the P2P lending platform. It is critical to have an understanding of these prospective obstacles.
Alternative options
Alternative feasible alternatives for debt consolidation include home equity loans, personal loans obtained from financial institutions or credit unions, and balance transfer credit cards.
It is advisable to evaluate these alternatives and select the one that most closely aligns with your financial objectives and situation.
Should you use P2P for debt consolidation?
While peer-to-peer (P2P) lending may present a feasible alternative for certain individuals seeking debt consolidation, it is not universally applicable.
Your financial circumstances are among the many variables that influence whether P2P lending is appropriate for debt consolidation. Consider the following if you are contemplating using P2P for debt consolidation:
Good credit score
Generally, a satisfactory credit score is a prerequisite to accessing loans on P2P lending platforms. P2P loans may offer more cost-effective alternatives for consolidating high-interest obligations if one is eligible for a reduced interest rate due to a favorable credit history.
High-interest debts
The interest rates on peer-to-peer loans are often lower than those on credit cards or cash loans. Some people find it hard to pay off bills with high interest rates. A peer-to-peer loan could help you save money on interest.
Fixed repayment schedule
With a P2P loan, your monthly payments are set, which makes it easier to stick to a budget and handle your debt. P2P lending can give you a structured way to pay back your loan, if you’d rather have one.
Single monthly payment
When you use peer-to-peer lending to consolidate your debts, all of your bills are put into one loan. You’ll only have to make one payment each month, which can make your financial life easier.
Final thoughts
To sum up, peer-to-peer loans give you freedom and can help you consolidate your debt, especially if you have good credit and a lot of debt with high interest rates. It’s important to remember, though, that they might not be the best choice for everyone.
If you have bad credit, want to borrow a lot of money, or need special financing for things like mortgages or car loans, you might be better off looking at other choices. Before taking out a P2P loan, you should always look at your finances and compare your other loan choices.