How to pay student loans using Defi
You must have heard that Aave is a decentralized lending protocol from where users can borrow, lend and earn interest on different kinds of crypto assets. There are reward programs as an added incentive from Aave through which you can distribute L2 tokens as well as AAVE tokens for lending and borrowing.
An instance of CeFi tragedy
There are many students who graduate from renowned universities in the US with huge student debt, sometimes the amount reaching almost $150,000 at a whopping interest rate of 8.8%. Students are generally naïve at this stage and they think that repaying this amount will not be anything difficult. But as time progresses and graduation comes to an end, they start thinking of ways of repaying the debt. And it is then you realize how big that loan amount is actually!
Some students are lucky in getting decent jobs right in the beginning. If you are among this lot, with the money you are able to reduce the debt amount and the interest rate percentage too. You might pay the refinancing fee to CeFi lenders at important steps. With refinancing at proper times, the interest rate might come to as low as 3.5% from 8.8%. With lower interest rates and less amount left for repayment, you can do away with your debt within a short span of time.
But things are not as rosy and easy as they look and seem.
With your CeFi loan sitting at 3.5% APR, monthly payments came to still a considerable amount. Deductions take place every month on the same day. An excellent way to lower your payment amount would be to put down a considerable part of the principal amount by selling some of your crypto holdings. But considering the appreciation in the crypto market, it would be wise to hold on to the currencies than pay off student loans with them.
This is where DeFi comes into the picture.
Advantages of DeFi loans
- Subsidized borrowing – Frankly, in DeFi, you are ‘paid’ to borrow. Doesn’t that sound interesting? But that’s the actual fact. You can consider this as a promotion for using the platform. This is almost like getting some referral bonus from a platform. On Aave, there is a handsome subsidy on the borrow rate, by AAVE, which is the protocol’s governance token.
- No definite or fixed period – There is no particular ‘repayment period’ and you can hold the loan for infinite time. There is no clause of minimum payment or even no monthly cycle. This clearly implies that you can pay the debt as and when you want – there are no hard and fast rules and regulations. In fact, the irregularity in payments will not even affect your credit score. You can also make payments instantly as contrary to slow methods of CeFi.
- Incentivized deposits – When you borrow money, you have to deposit collateral. Collateral is the way by which the protocol secures your loan. The platform gives you money with assurance that you will repay the money. The collateral is often given out to other users on the platform for reaping the benefits of interest payments. For depositing, you also get incentivized rewards in the form of cryptocurrency.
- Continuous upside exposure – You might have wanted to avoid selling ETH for missing out on potential future gains. But you might be gaining with continuous upside exposure. This is a tested and tried strategy. In CeFi, if you have held on to lots of stocks for a considerable period of time and you don’t want to decrease the exposure, you can borrow cheaply against the stocks.
- Self-repaying loans – You will be taken aback on learning that sometimes the loan pays for itself! This is strange but true. Calculations show that this is definitely possible.
Risks of DeFi loans
If you are smiling and thinking of the various things that you can do with these loans, stop right there. Along with the benefits, there are many risks that are associated with DeFi loans. Some important ones are as follows:
- Risk of liquidation – You have no idea how ETH will perform in future or if its rates will go down drastically. You might not be able to repay your loan and start selling ETH. This is known as liquidation. For avoiding this, pay a portion of your debt or add more collateral.
- Variable rates and returns – One thing about DeFi loans is that you cannot borrow at stable rates. As the rates are variable, the borrow APR could rise or fall depending on demand and supply. In fact, you might see that the DeFi loan is more expensive when compared to the CeFi loan at 3.5% interest rate. Some parts of the loan are also subsidized, so it might make the loan more expensive over the period.
- Market risk – This is always there when you take a loan. Therefore it is highly recommended that you keep a close eye on the loan health.
It is very difficult to say confidently at the moment, but most crypto gurus opine that DeFi will take over CeFi. The best thing is to learn about these latest technologies and implement them accordingly.
How to pay student loans using DeFi?
The volume of student loan debt in the United States is overwhelming – the figure is almost $1.73 trillion or more. There are more than 42.3 million borrowers who need to pay an average of almost $39,350 individually. Federal loan repayments are now paused by the government in US till January 2022. Now the interesting thing is that if you have taken a student loan in the US and looking for repayments, there are many avenues open in front of you. One prominent way is using crypto for debt repayment.
If you have crypto assets and want to repay your loans, you can explore the various decentralized finance (DeFi) options available. Though there are some risks involved, if done carefully, your problem can be sorted easily.
What is Defi?
For highly complex financial services, Blockchain is used extensively now. DeFi is actually an ecosystem of decentralized applications, or to be precise autonomous applications, which operate with the use of smart contracts. They are not dependent on some third-party company for their management.
Smart contracts are computer programs, which are self-executing and when proper conditions are met, certain functions are performed automatically. Every decentralized application contains such programs. One of the biggest advantages of DeFi applications is that they provide a wide variety of financial services. Some of them include insurance, loans, savings accounts, etc., which are generally offered by traditional financial institutions.
With DeFi applications, you can access these services, whatever be your credit history, your documentation, or your geographical location. With this platform, you can access uncollateralized and collateralized loans as well as earn interest by borrowing, lending, or staking different crypto assets.
Reasons why DeFi loans have become leading loan repayment option
Among the many reasons which have made DeFi so very popular with students is that they provide excellent interest rates. There are cases, where the borrowing rates are almost zero.
Another prominent feature is that you can access the loans with a flexible repayment period. You don’t have the compulsion of making loan repayments on some specific date in DeFi loans. In worse situations, you might skip making loan repayments for two months or so. And this will not even impact your credit score.
You might be worried that you don’t have a healthy credit score and so you will not be able to get a loan. But DeFi loans are given via smart contracts. Hence you needn’t worry about your poor credit score.
With DeFi, you can take loans against your crypto holdings so that you don’t have to pay capital gain taxes on sold digital assets. This means that you don’t have to sell your crypto holdings for settling any debt or for financing any kind of project.
In DeFi loans, the protocols are such that they incentivize users for borrowing. Precisely it is like paying someone for taking a loan. With this, it is possible to attract liquidity, and users are rewarded for their contribution to the ecosystem. Rewards are generally in the form of governance tokens, with which participants can contribute to the running of the protocol on a day-to-day basis.
Rates of DeFi loans
There are various platforms like Maker, Aave, and Compound from where you can access loans. However, the interest rates here are fluctuating. There are different factors, which determine the rates. You have to check the demand quotient of the digital asset, which is in focus now. There is also the factor of the protocol being used. It is possible to take out loans on DeFi protocols with fixed interest rates. But they are not very common.
On Compound, the average 30-days lending rate is in the range 0.01% to 5.12%. On Aave, the range is 0.01% to 5.89%. Borrowing rates on Compound are in the range 2.79% to 28.06% and on Aave between 0.04% and 168.98%. No statistics regarding Maker were available.
You will be surprised to know that there are many options where there is no implementation of any loan rates. This means that the borrower will have to repay just the sum which he/she has borrowed. Liquidity is a DeFi solution, which offers loans without any interest.
When you are looking to pay off your student loans with DeFi techniques, you must do thorough homework. Randomly jumping on the bandwagon without any proper knowledge might expose the borrower to risks.