What to know before taking an online loan to pay off debt

AP News
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Posted: Oct 21, 2015 10:33 AM

NEW YORK (AP) — Online lenders are pitching a fast way to get rid of credit card debt: Take out one of their loans and use it to pay off the card balances.

Those offers may sound tempting, but be careful, financial advisers say. Those who can't control their spending may end up in more debt than they started with.

"If you're not disciplined, I would not recommend it," says Felicia Gopaul, a certified financial planner in Irvine, California.

Online lenders such as Lending Club, Upstart and Prosper offer personal loans quicker than a bank. Borrowers apply online and cash is usually deposited into a bank account in a few days. Payments are taken from checking accounts automatically every month. The lenders, which advertise heavily through emails and social media, are growing in popularity. They lent $5.5 billion to Americans last year, according to a report by accounting company PricewaterhouseCoopers, and that number is expected to reach $150 billion in the next decade.

Allie Dreskin borrowed $3,500 through Prosper after seeing an ad online two years ago. She used the money to pay off three credit cards and a bank loan, all of which charged annual percentage rates of more than 20 percent. Dreskin, who works at a nonprofit in Washington, says the high interest rates were making it hard to pay off the $4,000 debt quickly. The loan from Prosper had an APR of 7 percent and would be paid off within four years.

"I pay less at the end and I pay it off sooner," Dreskin says.

If you're thinking about consolidating debt using an online loan, consider these factors:

CHECK THE INTEREST RATE

Make sure the loan's APR is lower than that of your credit cards. The APRs on online loans can vary greatly, typically between 5 percent and 40 percent, depending on your credit score. The average credit card has an APR of 15 percent, according to CreditCards.com. Check your credit card statements for the APR. It only makes sense to take a loan if it is cheaper than the debt you're paying off, says Mike Brady, the founder and president of Generosity Wealth Management in Boulder, Colorado. "If you have really bad credit, there might not be a huge advantage," he says.

Online lenders list their APRs and fees on their websites, but you may not know exactly what they will charge you until you apply.

KNOW THE FEES

Online lenders typically charge origination fees of about 5 percent of the total loan amount. The fee is deducted directly from the loan. So if you borrow $10,000, for example, you'll receive $9,500 in your bank account.

Watch out for other potential costs. You may be charged for a late payment, or, some even charge if you want to pay by check instead of automatically through your bank account. Fees are listed on each company's website and on their loan agreements. Call lenders to verify their fees.

CREATE A BUDGET

Make sure you'll be able to pay the loan every month. Most online lenders take money directly from a checking account monthly, so you'll have little control on when the payment is made. Know when the payment is due, and budget for it. Lenders will typically tell you how much you're expected to pay each month after applying.

CUT THE CARDS

A new loan won't help much if you load up your cards again with balances. Don't close your accounts — not using them can improve your credit score, Brady says. But do cut up the cards to prevent the temptation of using them and falling deeper into debt.

"There is a behavior issue many times," says Brady. "They just ring up the debt again if their behavior doesn't change."

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