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A question from LiveCheap reader J E: "I have a $20,000+ loan currently at 17.99% interest rate for 55 months and I am considering refinancing it with a peer-to-peer  lender at 11% plus a $500 origination fee for 36 months. The payment on the new loan will be $681 vs $570 on the old loan. I am leery of peer-to-peer lending. I am a nurse with plenty of opportunity for overtime and I plan on at least paying double the payment, if not $800 or more. Can you tell me anything about peer-to-peer lending and whether I can trust them?"
J E, this is a great question as many people are interested in whether they can save money through a peer-to-peer lender. The concept of P2P lending is solid. Retail investors that are not able to get high enough interest rates on their money can lend their money to people like you who will get a lower rate. The P2P lender takes a fee and everyone wins. In theory at least. The two big P2P lenders are The Lending Club and Prosper. The big issues that are hitting P2P lenders are the same that are hitting the rest of the banking industry: massive defaults. But from your perspective, you really don't care because once your loan is funded and you pay it back in a timely fashion, that's not going to be an issue. It's the lender that's taking the risk.
Original Loan
First, realize that you are employed in one of the most job secure professions in a field that is insulated from the traumas of the current economic slump. Nurses will continue to be in high demand and the health industry will continue to offer opportunities for career growth. I think it's fair to assume that you can get all the overtime that you need and this will help you pay down your loan by that extra $600 to 800 a month. Your aggressive pay-down actually makes the interest rate differential not as large even though the current rate you are paying is highway robbery. Right now, if you pay your current loan off in 55 months, you will pay $9,500 in interest over that time. If you pay the $1,400 a month as you indicate, you will cut that down to $2,700 in interest. The biggest improvement you can make is to pay the loan at an accelerated pace. So while the loan you have is awful, you can negate that by paying it quickly (which at that rate you are highly motivated to do).
Peer-to-Peer loan:
Th new loan really isn't that great either. The $500 fee and the 11% rate makes it fairly expensive given the short term of 36 months. The upfront fee makes the cost savings much lower due to your planned aggressive payback. Your monthly payment also goes up which gives you lower flexibility for a marginally better rate. With the right lender, you should be able to do much better than this rate. If you do decide to go with the P2P loan, you will end up paying $4,200 in financing which is a vast improvement on the $9,500 you will pay on your current loan. But most of what you save will not be because of the difference in rates. What really lowers your finance charges is the fact that you will pay back the money in 36 months instead of 55 months. If you decide to pay off the P2P loan in an accelerated fashion and stick to your plan to make a $1,400 payment each month, you can reduce your financing cost to about $2,100 and get it paid off in 16 months.
So here's the final score - if you really stick to the program and make that $1,400 payment each month - you'll end up paying $2,700 on your current loan and $2,100 on a P2P loan. Saving $600 in interest is a nice bit of change but it's not much of a return for your efforts and you will lose a little flexibility because the minimum payment will increase. I think you can do better with the option I have on the next page.
Credit Union Personal Loan
I bank with PenFed Credit Union which is a credit union that has a lot of military members (note: I have no business financial relationship with them). The loophole is that you don't actually have to be in the military, you just have to sponsor one of their charities one time for a nominal fee. It's a good cause and you'll end up the big winner. Their personal loan rates up to $25,000 are 7.99% through the Internet. You can probably find someone out there that has a better rate, but 8 percent is pretty good for a personal loan. What makes it even more special is that the rate is the same for 36, 48, and 60 month loans. Why is PenFed so inexpensive? My gut feeling is that with a huge proportion of military members they have lower default rates due to the job security and steady income of their members. Good Marines pay their bills.
Compared to the terms of the P2P loan, with a personal loan from this credit union, you will only pay $2,600 in interest over 36 months for a saving of $1,600. If you really stick with your plan to pay $1,400 per month, with a loan from the credit union, you can pay off the entire balance in 15 months and incur only $1,100 in interest. That's still $1,000 less in financing than what you pay on the P2P and $1,600 less than your current loan. The $500 origination on the P2P really makes a difference. Banks and P2P lenders use these origination fees to juice their returns and they are often not factored in by borrowers. In your case with the likelihood of accelerated payoff, it makes the P2P loan very unattractive.
The chart below summarizes the loans.
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Interest & Fees Expense
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Original |
P2P |
Credit Union |
| Full Term* |
$ 9,539 |
$ 4,215 |
$ 2,661 |
| Accelerated |
$ 2,731 |
$ 2,069 |
$ 1,136 |
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|
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Note: the full term original is for 55 months while the P2P and Credit Union are for 36 months.
The point I would make to all readers is that when you refinance, make it worth it. Refinancing just to lower your payments by $50 a month is almost too much effort for the time and effort it takes. Research all your options and when you get to the lowest rate with the minimum fees, refinance and then focus on repaying your loan as fast as possible. As in J E's case, the biggest difference you can make for yourself is to pay down your loans aggressively.
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