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Debt Reduction

In your personal finance journey, you may or may not have come across peer-to-peer (P2P) lending platforms. The great news is, these have proven to be solid investments over the past few years, providing much higher returns than what you could earn on bank investments. But we have to wonder:  will P2P platforms continue to be reliable investments, particularly if the economy begins to weaken?

p2p

Since P2P lending only got its start in the early 2000s, we don’t have a particularly strong or reliable track record to fall back on. The first platforms only began coming on line as the last recession – the Financial Meltdown – was unfolding. So while they have been a picture of success since their inception, we don’t really know how they’ll hold up under pressure.

What Effect a Weakening Economy Might have on P2P Lending

In the absence of any substantial performance data from the last recession, we can only speculate what effect a weak economy will have on P2P lending. But we can rely on the general performance of loans in past recessions for strong clues.

When the economy declines, asset prices fall and unemployment rises. In turn, default rates on virtually all types of loans rise. Since P2P loans are unsecured and taken for a variety of purposes, they most closely relate to credit cards.

According to the Federal Reserve, credit card default rates were at 2.34% at the end of 2016. However, they hit a high of 6.77% during the second quarter of 2009, in the middle of the Financial Meltdown.

While P2P loans are priced to accommodate certain default levels, they are based on the most recent default experience. Should default rates rise to something close to what they were in 2009, P2P loans priced based on today’s default rates will likely suffer disproportionate losses in interest rate return.

The Flood of Institutional Money Might Weaken Lending Standards

The basic concept of P2P lending is simple. Individual borrowers come to lending sites in search of loans, which will ultimately be funded by individual investors. But as interest rates have continued low, institutional participation in P2P lending has grown, as banks and other large lenders seek higher returns. For example, Lending Club recently reported that banks funded 31% of loan originations in the fourth quarter of 2016, compared with 13% in the third quarter.

One of the concerns over increased institutional participation is loan quality. As institutions bring larger amounts of capital into the space, loan quality may decline. That can happen as P2P lenders lower underwriting standards in order to draw in a larger number of loans. As they do, the quality of those loans will gradually decline, eventually increasing the rate of default.

It remains to be seen if that will play out as a worst-case scenario. However, not only is the industry itself relatively new, but institutional participation is only very recent. That means that the impact of greater institutional participation has yet to be felt.

Lending Club’s 2016 Scandal

In May of 2016, Lending Club’s CEO, Renaud Laplanche, was forced to resign amid a scandal. A summary of the event disclosed that:

Lending Club conducted a review, under the supervision of a sub-committee of the board of directors and with the assistance of independent outside counsel and other advisors, regarding non-conforming sales to a single, accredited institutional investor of $22 million of near-prime loans. The loans in question failed to conform to the investor’s express instructions as to a non-credit and non-pricing element. Certain personnel apparently were aware that the sale did not meet the investor’s criteria…The review further discovered another matter unrelated to the sale of the loans, involving a failure to inform the board’s Risk Committee of personal interests held in a third party fund while the Company was contemplating an investment in the same fund.

Since Laplanche’s resignation, earnings have gone negative three quarters in a row. What’s more, the pattern of losses are expected to continue through 2017. The company is forecasting losses of $69 million to $84 million, on revenue in the range of $565 million to $595 million for the year. The company cites the loss of investors in the aftermath of last year’s scandal.

We should reasonably expect that Lending Club, as the largest platform in the P2P space, will recover. However the episode should serve as a warning that the development of P2P lending won’t necessarily be an elevator ride straight up. With the number of P2P lenders increasing steadily, there are bound to be more negative surprises.

Read More About Reducing Risk With Lending Club here.

That might make a strong case for spreading your P2P investments across several lending platforms.

The Nature of P2P Loans Themselves

Despite the positive overall performance of P2P lending over the past few years, the practice contains two built-in issues.

The first is the fact that the loans are largely comprised of debt consolidation loans. Though such a loan can potentially improve a borrower’s financial situation by lowering the interest rate and monthly payment that he or she is paying, it also holds the potential to borrow even more money.

For example, many borrowers engage in serial debt consolidation. They have a few credit cards, and then do a debt consolidation to lower the monthly payment. But one or two years into the debt consolidation, and they rack up more credit cards. Eventually, there’s another debt consolidation – and maybe even a third, and a fourth.

From a risk standpoint, the problem is that the borrower is never actually paying off debt. Often, the debt consolidation simply sets the stage for the next round of borrowing. As that cycle continues, the risk of default on the latest debt consolidation loan increases.

The second major concern is that most P2P loans are unsecured. Borrowers can typically take loans as high as $40,000, and for nearly any purpose, without having to put up any collateral. In the event of a loan default, there will be no assets to seize in order to satisfy the debt.

In an economy with low unemployment, low interest rates, and rising asset prices, neither issue is a major concern. But when the economy eventually weakens, both run more than a slight chance of becoming more pronounced.

Positioning Your P2P Portfolio for Leaner Times

All of this should be a reminder that P2P lending, like virtually all other types of investing, is not completely risk-free. And despite recent healthy performance, the situation could change — and change dramatically — in the event of an economic slowdown.

None of this is to discourage investing in P2P lending. Since the next recession is virtually inevitable, though, now is the time to prepare your investments for a change in circumstances.

Prepare Now: Sweat In Up Markets So You Don’t Bleed In Down Markets

How can you protect yourself?

  • As noted earlier, consider investing on several P2P lending platforms. That will minimize the risks associated with any one platform.
  • Don’t use P2P investing as a substitute for the fixed income portion of your portfolio. Instead, make it part of your fixed income investments, to offset and increase the lower rates paid on traditional but safer fixed income investments. You should have both P2P and traditional fixed income investments.
  • Invest across various risk grades, despite the fact that returns may be higher on the weaker grades. Lending Club’s Statistics page (“Loan Performance Details” chart) shows that default rates increase substantially with each lower credit grade.

In regard to the last item in particular, it’s important to realize that default rates are likely to increase more dramatically in the lower credit grades in the face of a bad economy. Those are, after all, the highest risk loans being made.

We don’t have much information available as to how well P2P investing performed in the last recession. But that makes it even more important, at this late stage of the current economic recovery, to make some reasonable assumptions about what’s likely to play out. This will allow us to best prepare for it.

How do you think P2P investing will do when the economy takes the next nosedive?

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Along with losing weight, getting out of debt is the most popular New Year’s resolutions in the United States. This resolution, like all others, unfortunately tends to be forgotten within weeks. Well, if you resolved to get out of debt this year — and haven’t yet abandoned that idea now that we are at the end of January– here are some ideas for not losing sight of the goal.

CLIMB DEBT

Don’t focus on zero debt, focus on financial freedom

Debt is at worst slavery; at best, it’s willful indentured servitude.

Say your family takes home $2,500 per month from your job after taxes, but your credit cards, loans, and rent/mortgage total $2,000 each month. This means that you work only one-fifth of your hours for yourself. The remaining four-fifths of your time at your job is exclusively for your creditors. You might as well just hand your paycheck over or work off your debt directly with the credit card companies.

Unlike slavery, though, you are free to leave this arrangement (your job) at any time. You just need to simply quit and look for another job with a pay increase. However, that is not always a simple or practical solution.

If it motivates you, think about what you would do with your freedom from debt. Without having to pay credit card companies, you would have the freedom to choose where your take-home pay goes. If you want to save up for a vacation, place pictures of your favorite getaway spot around your house.

Replace bad habits

Excessive shopping can be a habit. Many compulsive shoppers who go into debt do so because shopping helps them deal with difficult emotions like anger, frustration, and stress. The excitement of shopping helps to temporarily improve a person’s mood. But this habit can be replaced with a healthier alternative.

If starting a shopping trip helps you deal with difficult emotions, replace shopping with jogging, running, or another physical activity. While the act of spending money improves the mood of habitual shoppers, physical activity improves anyone’s mood. This is due to endorphins — natural, mood-altering chemicals released by the body in both situations.

Make getting out of debt fun

The concept of “fun” is personally subjective. One thing that I find fun, someone else might find mundane.

For example: when I was in debt, I liked watching the colorful monthly reporting graphs in Microsoft Money get close to crossing the x-axis of $0 net worth. I fully understand that might not motivate everyone the same way.

Related: How and Why to Track Your Net Worth

Rewards can be great motivators, too — just make sure they aren’t big rewards that will impact your finances negatively. Paying off a student loan and then blowing $200 on a steak and lobster dinner, for example, isn’t very smart. Do something small, yet still enjoyable. You could treat yourself to a movie night every time you pay off a credit card, or plan that weekend hike that you’ve been meaning to do. Celebrate at every possible milestone, but within reason.

Visualize your debt reduction

Losing weight is easy to visualize. Improving finances? Not quite so easy. I’ve seen videos posted online involving time-lapse photography to illustrate weight loss over time. One photograph is taken each week at the same location and in the same position, so when played consecutively from start to finish, the change over time is apparent. You may not realize it, but you can do the same with your debt.

Here are a few visualization tips:

  • When you pay off a credit card, cut it up using a shredder. Save the plastic confetti in a bag and watch it expand as you blow through card after card.
  • Look at your credit card statements before you go to sleep each night. The bad dreams you have will subside when your statements are small enough that they don’t cause anxiety.
  • Here is an extreme option, for those who REALLY need a motivator: If you’ve paid off 20% of your mortgage, paint 80% of your house in a color you don’t like. Once a year, determine how much more you’ve paid off, and paint the corresponding amount in a color you do like. You’ll be encouraged to pay off your mortgage in full just so you can live in a house painted the way you prefer.

Learn More: Should You Ever Cancel a Credit Card?

Do something positive every day. The key to making a resolution stick is to keep it in front of you every day. If your loan or credit card allows you, and if you are not charged an extra fee, make small payments every day before you go to work. Look at your net worth in Mint if it reminds you of your goal. Work an extra hour if it means you’ll get more money for paying off your debt.

Recruit your family and friends. Having a support system is vital, but many people don’t want to let people know about their financial troubles. I think it’s important to have at least one person you trust to talk to about financial issues. It helps to share goals like this because they are often not real until they are spoken out loud with a witness. If no one is aware of your goal to pay off debt, it’s easier to admit defeat without first offering 110 percent of your effort.

Consider your financial options. To truly get started you need to make some financial decisions. It is true that anything you do is better than nothing, but you need to have a plan. First, can you consolidate your debt onto one low-rate card? Call your credit card issuers and ask; the phone numbers are on the back of each credit card. Do you qualify for a loan through a peer-to-peer network? If you have a good credit score, you might find favorable loan terms.

Decide how fast you want to get out of debt and how much you want to pay. If you want to pay the least and succeed the fastest, you’ll want to examine the Debt Avalanche method. If you believe that a small success earlier on the path is important to keep you motivated, check out the Debt Snowball. Research your options and give it thorough thought.

What tips do you have for keeping a resolution to get out of debt?

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There are so many different ways to organize, prioritize, and classify your tasks and responsibilities. You’d probably need a couple years just to sort through all of them on your own. You can have an organizer on your computer, your phone, in your pocket, or a notebook. If you’re short of paper, you can just scribble on your hand.

Even with all of the new ways to get organized, the most effective tool for me is still the simple, classic “To Do” list. My to-do list is nothing fancy, just a list of things that I need to accomplish. For some reason, though, this list motivates me to be smart with my time and get things done.

One of the reasons these lists are so effective is because they help you define what needs to be done. One of my favorite things to put at the top of a to-do list is “start a to-do list” — that way I can cross something out right away! Nothing like building momentum right off the bat.

In fact, checklists are so powerful that they inspired an excellent book, The Checklist Manifesto, by Atul Gawande.

This principle can be applied in any aspect of life. You can use a to-do list at work, at home, or even in relation to different goals you have. My wife and I even have a sort of ‘Financial To-Do List,’ covering our money goals. It has helped us get started and avoid wasting time.

A to-do list is particularly power when it comes to finances.

The Benefits of a Financial Checklist

Stay Organized

The list helps us know what bills need to be paid and when they’re due, what major tasks or purchases we might have coming up, and — perhaps most importantly — when we’re going to be paid. A well-defined to-do list answers all of the questions about what needs to be done and when. This helps you use your time more effectively.

Get More Done

Because we’re using our time more effectively, we can use time in more productive ways. For example, we might have spent hours poring over our budget or trying to find the electric bill. Instead, our newfound organization allows us to avoid these little time wasters and streamlines the process. We can get back to making money, fine-tuning our savings strategies, and looking for new ways to cut back. Or, we can quit thinking about money altogether and just go enjoy ourselves for a bit.

Meet Your Goals

We have all sorts of tasks on our list, both big and small. An easy way to design a strategy like this (if you’re using a word processing program or a notebook) is to use a list:

  • Big Goal 1
  • Little Goal A
  • Little Goal B
  • Big Goal 2

For example, if your big goal is to save $1,000 for your emergency fund, your To-Do list could look like this:

  • Save $1,000 Emergency Fund
  • Save $75 from each bi-weekly paycheck for 4 months ($600)
  • Take lunch to work 2/wk for 4 months and add savings ($25/wk) to emergency fund

See how easy that is? Now you’ve got a goal, and you know exactly what you need to do for it! Of course, you can substitute in anything you like.

The beauty of these lists is that they are completely scalable — that is, they grow with you. If you finish your emergency savings goal, you can just start your next goal: “Pay off car debt” or whatever it is on the next line. Figure out how you’re going to do it, and break the big “to-do” down into smaller tasks. Then, you’re well on your way to leveraging your simple list as an effective financial tool.

The Financial Checklist

Your specific to-do list will depend on your circumstances. That said, here are some Financial Checklist ideas to get you started:

Money Management Checklist

  • Create a budget
  • Compare your budget to actual spending
  • Balance your checkbook
  • Balance your credit card account
  • Conduct a spending audit

Credit & Debt Checklist

  • Check your credit score (here’s how)
  • Check your credit report for errors
  • Refinance credit card debt to 0% (here are current 0% offers)
  • Consider refinancing school loans
  • Consider refinancing a mortgage
  • Use the debt avalanche to pay down your debt

Banking & Credit Cards

  • Eliminate checking account fees
  • Confirm that your savings account offers a high yield (here are some options)
  • Set up direct deposit
  • Make sure your credit cards pay excellent rewards (here are our favorite cash back cards)

Investing

  • Check the fees of your investments
  • Confirm your asset allocation aligns with your investment goals
  • Rebalance your portfolio
  • Max out your 401k
  • Max out your IRA
  • Consider an HSA if you have a high deductible insurance plan

Tools

You don’t need anything special to start a to-do list. You can put it on a piece of paper in your wallet, a whiteboard in your kitchen, or keep it on your phone or computer. The “Financial To-Do” list is a completely customizable, easy-to-use money (and life) tool for anyone.

That being said, there is one free tool worth considering: Asana. Asana is a free online tool that tracks tasks. It allows you to create a team and assign tasks to team members. For couples, it can be a great way to share, save, delegate, and organize information on anything.

There are several reasons why Asana is perfect for a financial checklist:

  • It’s free
  • It’s easy to use
  • Tasks can be scheduled to recur on a regular basis (e.g., rebalance your investments once a year)
  • You can attach spreadsheets and other files to a task
  • You can leave comments for each task, perfect for communicating with your significant other

However you approach a Financial Checklist, and whatever tools you use, it can be a great way to improve your finances over the next year.

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It’s late May, and a new crop of students is preparing to go on to college. One of my less pleasant memories was the agonizing process of securing financing so I could pursue my degree. Though it’s many years later, I’d like to share what I learned that can make paying student loans more manageable and less onerous.

Of course, it was much easier when I went to college than it is now. Even adjusted for inflation, college education was much less expensive then and student loans were a better deal.

The interest rates were actually fairly similar to today’s; but I attended college back when mortgage rates were around 15 percent, so low, single-digit student loan rates represented much more of a discount.

Because student loan debt was less burdensome when I graduated, despite the fact that I took on the debt in a desperate and disorganized way, I was able to pay my loans off early, within five years. These days, the financial stakes are higher, and it takes more planning to make student loan debt manageable.

How to reduce student loan debt

Here are some things students and their parents should consider to reduce student loan debt in the first place:

  1. Consider value for your education dollar. Education is a wildly inefficient market. By that, I don’t mean that the schools themselves are disorganized. What I mean is that if you think of education as a consumer market with heavy competition for student dollars, it is amazing how wide the cost differences are. Even if you excuse the cost of elite colleges as the price you have to pay for a premium product, looking at more run-of-the-mill colleges one finds huge cost differences — sometimes representing tens of thousands of dollars a year — which do not seem generally to correlate with differences in quality. The nice thing about inefficient markets is that they make bargains available, but only to discerning consumers who take the time to shop around. Cheap should not be your primary criterion for choosing a school, but value for money should be high up on your list.
  2. Understand the qualifications needed for what you plan to do. One reason it is not out of place to think of education as a consumer market is that there is so much hard selling of degree programs these days. Often times, colleges heavily advertise degree programs that relate to a trendy career choice, but those degrees do not represent the full qualifications necessary to compete in that field. Don’t just choose a degree program because it sounds like something you’d like to study; think ahead to what you would like to do for a living, and then work backward to identify the degrees necessary to get hired in that field.
  3. Know what the market is for your planned career. Speaking of thinking ahead, research what demand there is for your planned career. The Bureau of Labor Statistics is a good source for information on hiring trends by occupation. I’m not saying you can’t choose more of a niche field because it is something you love, but you should know what your odds of making a living in that field are before you spend time and money preparing for it.
  4. Explore all your financial aid options. The federal government has a program called Free Application for Federal Student Aid, or FAFSA. This is a good clearing house for information and application materials for several types of student financial aid, so you can find the resources you need and choose the best ones for your situation.
  5. Prioritize your financial aid types. If there are grants or scholarships available — sources of aid that don’t require repayment — make the most of those before you borrow money. Then, choose federally-backed student loans first, because these offer good loan terms and some repayment flexibility. Private student loans should be your last priority.
  6. Use savings resources wisely. If you have saved money for college, put it in vehicles that will make it available when you need it and yet earn you the most interest in the meantime. You’ll find that if you are able to plan six months or more ahead, you can find CD rates that will do better for you than what you could earn in a savings account.
  7. Check how your repayment schedules add up before you borrow. Every loan you sign up for will probably provide a repayment schedule, but the reality check is to see how those repayment schedules add up as you take on multiple loans. Graduating students are often shocked by the burden they are facing, but there is no excuse for taking on obligations you won’t be able to meet.
  8. This time is too expensive to waste. Don’t be intimidated by the financial responsibility facing you, but respect it and use it for motivation. Blowing off classes and prolonging your time in school is an awfully expensive luxury. Getting your degree on time can save you a great deal of money.
  9. Remember the bigger picture cost of failing to pay. There is a lot of resentment among recent graduates about the financial burden they’ve taken on with student loans, and this is often expressed as talk about not paying back those loans — either by taking advantage of government forgiveness programs, lobbying for student loan relief, or simply defaulting. Just remember that every student who fails to pay back a loan makes it harder for subsequent students to get those loans. If you approach taking on and paying back loans responsibly, you can make the system work for you and future generations of students.

When you think about it, financing college represents a sort of hand-off of responsibility from the parent’s generation to the student’s. The parent often helps pay for college and guides the student in finding and organizing financing. In the long run though, it is the student left making the student loan payments for years to come — often until he or she has kids and has to start thinking for their college education.

That passing down of financial responsibilities between generations makes this an ideal time to work together to find and plan educational financing, so the older generation can share what they’ve learned and the younger generation can step up and make informed decisions about the process rather than just going along for the ride. Given the nature of the challenge involved, both an older person’s knowledge and a younger person’s eye to the future can bring valuable perspective to the process.

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Balance Transfer Cards for Fair, Average or Excellent Credit

by Richard Barrington

[Editorial note: This offer was last updated on July 13, 2016.] Are you still wrestling down holiday debt? Zero-interest balance transfer credit card offers can help you meet this challenge, but only if you know what to look for. Otherwise, you will end up paying interest anyway, which is exactly what the credit card companies […]

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Psychological Advantages of the Debt Avalanche

by Luke Landes
Debt Snowball

The realist in me recognizes that the best plan for getting out of debt is any plan that allows someone to achieve that goal. The realist is constantly at odds with the optimist in me, the part of me that wants people to be high achievers, to strive for excellence, and to seek an informed […]

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Do Something About Debt

by Donna Freedman
Credit card debt

This is a guest article by Donna Freedman. Donna has been a staff writer for MSN Money and Get Rich Slowly. She now lives and writes the frugal life in Anchorage, Alaska for Money Talks News and her own blog, Surviving and Thriving. Got debt? Do something about it. That’s the focus of a new […]

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Capital One 360 Customer Service: Unsolved Issue With Customer’s Mortgage

by Luke Landes
Capital One 360

When Capital One purchased ING Direct and ultimately rebranded the bank as “Capital One 360,” long-time customers of the online bank asked the same questions. Would Capital One continue ING Direct’s tradition of competitive rates and excellent customer service? Not everyone’s experience with ING Direct has been perfect, but overall, the bank was as beloved […]

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Income-Based Repayment Student Loan Plans

by Luke Landes
College Graduate

In his latest Naked With Cash update, participant JW discussed his student loans. Due to his income, which happens to be at a low level, the amount he owes each month to pay back his education loan is zero. How is this possible? He enrolled in a feature for low-income households with certain types of […]

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Time-Barred Debts: Statute of Limitations

by John Ulzheimer
Time-Barred debts: statute of limitations

When you take on a credit obligation, or liability, you normally sign an agreement or promissory note requiring pay back of the debt. What you’ve just done is incurred what’s referred to as “contract debt.” If you default on a contract debt, such as a credit card, the creditor can and likely will vigorously pursue […]

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