One of the most common reasons for borrowing money through Zopa’s peer-to-peer platform is to consolidate existing debts.
Why you should consider a debt consolidation loan for 2016
For example, if you’re already deep in the red on your credit card or current account overdraft, you could be paying an annual interest of as much as 20% — not to mention the extra charges that are typically applied to people who go overdrawn these days. In such circumstances it can make a lot of sense to shift debts to a single personal loan with a lower rate of interest – and which you know will be paid off within a specific timeframe.
People often use the New Year as the opportunity to kick-start this kind of debt consolidation. So let’s take the example of someone with £8,000 borrowed on their credit cards and/or overdrafts who wants to move their entire debt to a Zopa loan at the start of 2016.
Debt consolidation loans – about the rates
At the moment, the best rates are available for loans which run over two or three years. (Typically, the interest charged by any lender on one-year loans tends to be higher because the administration costs involved in making the loan can’t be spread out as much.)
The current APR (annual percentage rate) on a two- or three-year Zopa loan for £8,000 is 3.9%. This is the interest that will be charged to most customers, but in reality some will face higher costs depending on the state of their credit ratings.
Paying back the loan
If our borrower opts for the three-year loan, their monthly repayments will be just under £236 at 3.9% and the total cost of paying off the £8,000 in 36 instalments will be £8,486. (If the debt had been left on a credit card charging an APR of 20% — which is not uncommon – clearing the debt over the same three-year period would mean monthly repayments of almost £300 and a total cost of £10,700.)
Switching from repayments to lending
This would put our – now debt-free – borrower in a position at the beginning of 2019 to start lending their money. At today’s rates, they would be able to lend on the Zopa platform at a projected annual return of 5% after defaults and charges.
Let’s say the same £236 that had been used to pay off the loan was instead lent out every month. Over the next three years, this would generate a nest egg of £8,895 – and our hypothetical borrower/lender would be almost £17,000 better off than at the start of the process six years earlier.
Understanding peer-to-peer lending
Bear in mind that when you lend on a P2P platform, your capital is at risk of borrowers defaulting. With Zopa, however, this risk is mitigated by having loans spread out among a large number of borrowers. Zopa also has a Safeguard Fund which, while not a guarantee or insurance product, can help make up any losses suffered by lenders.
So if you are thinking about how to deal with your current debts, it is well worth considering a P2P loan. And by implementing the kind of borrower-to-lender strategy outlined above, you will slowly but surely be able to put your finances in excellent working order.