Shutterstock

The process of climbing out of debt often pits borrowers against their banks. Between double-digit penalty interest rates, debt forgiveness programs, or filing for bankruptcy in extreme cases, none of the common alternatives are particularly friendly to your finances, credit score or well-being.

Already a $7 billion market at large, the recent trend of peer-to-peer lending—also known as marketplace lending, or social lending— is gaining popularity as a no-frills avenue for consolidating credit card debt.

How Marketplace Lending Works

Popular marketplace lending sites, like Prosper, Lending Tree, Upstart and Payoff, all share the same goal: matching borrowers with investors. In this marketplace, a borrower (namely, a person who owes money on his credit cards) enters the amount he’s looking to borrow, and what the money will be used for.

In turn, an interested investor can invest in the request while earning a percentage of the repaid money. For investors, marketplace lending allows for higher returns than many other investments, like deposit accounts.

According to Fox Business, marketplace lending is a popular means of consolidating debt for many. More than 75 percent of Lending Club borrowers and 50 percent of Prosper borrowers use the sites to pay off debt—much of which is for credit card debt. These companies are gaining the attention of investors to fund them, as well.

Benefits of Marketplace Lending

People with credit card debt might find several advantages with marketplace lending:

It’s more transparent than a bank. Generally speaking, borrowers might have an easier time finding a loan through the marketplace, since standards are more flexible than a bank. Like a bank, marketplace lending sites are audited for accountability. Plus, there’s no middleman to be found, eliminating most of the opaque roadblocks a person in debt might encounter on the traditional route—like being offered another credit card to pay off your existing credit card debt.

Terms and conditions are more amenable. The Huffington Post notes that rates may start as low as 6 percent, and loan amounts can range from as low as $5,000 to as high as $35,000. Standard payback terms are an average of three years to five years.

Investors win out, too. Not only are they putting their faith in borrowers, prompting them to reduce their debts, investors can earn interest on their investments, higher than what they might find in a comparably termed certificate of deposit or other accounts. According to Mint.com, investors can earn an average of 9.64 percent on the marketplace loans they invest in.

Social Lending Cons

But P2P lending isn’t for everyone:

Rates can make it counterintuitive. Despite the attractiveness of low interest rates with marketplace lenders, they can still run into the mid-20 percent range.

Fees can make borrowing financially difficult, as well. According to NerdWallet, loan origination fees can also creep up into the 5 percent range, which could increase the loan amount a borrower needs to meet his debt obligations.

It requires a debt-reduction strategy. This isn’t a disadvantage of marketplace lending sites, but a drawback caused by borrowers. Your marketplace loan is still a loan, with interest and penalties attached; if you have no plan in place to repay the money, a marketplace loan won’t serve any purpose but to transfer your financial problems to another medium.

Potential borrowers should remember that their credit scores are critical to being approved. Most lending sites expect above-average FICO scores of 640 to about 700, and a debt-to-income ratio no higher than 25 percent.

Your credit card debt should be the only black mark to your credit history to maximize your chances of being eligible. You might be disqualified if you’ve had any delinquencies, bankruptcies or a high number of credit inquiries in the last seven years. If you default on your loan, you’re still held legally liable as you would with a conventional loan.

Before considering a marketplace loan, you should work to improve your financial situation to position yourself to qualify for an attractive borrowing rate. Take the necessary steps to improve your credit and keep your desired loan amount as low as possible; that way, you will present yourself to investors as a creditworthy and trustworthy borrower.

For investors, keep in mind that you might lose part of your investment if your borrower defaults on the loan. Prosper, which is a top-rated marketplace lending site, has a 6.62 percent default rate, for instance. On LendingClub, that stat is 5.13 percent.

And above all else, borrowers and investors should be completely honest and forthright with each other regarding the terms of the loan. Neither side should withhold important financial details; most marketplace lending sites enable both parties to ask and answer questions during the entire lending process.

By putting the “social” in social lending, marketplace lending sites allow borrowers and lenders to come together and create mutually beneficial debt management and investment strategies.