Personal loans are one of the most commonly used financial tools for consumers as they offer a slew of benefits not found with credit cards or home equity loans. Borrowers appreciate the simple structure of personal loans in terms of the often fixed interest rate and steady monthly payment. This lending tool makes it easy to borrow for a specific purpose, whether that be high-interest debt consolidation, a major purchase, or a cushion for a cash-flow lull.
According to a recent report published by TransUnion, one of the major credit bureaus in the United States, personal loan borrowing continues to thrive in the post-recession economic environment. In the third quarter of 2016, total personal loan balances exceeded $100 billion across more than 15 million consumers. This represents growth of 1.5 million in the number of consumer loan borrowers since the third quarter of 2015.
Why Personal Loans?
Several factors play a role in the growing personal loan market, not the least of which is increased competition. Borrowers now have access to a vast number of personal loan lenders, including the conventional array of banks and credit unions, and non-traditional online, or marketplace, lenders. Highly qualified borrowers – individuals who have exemplary credit, strong income, and a low debt-to-income ratio – are more apt to find affordable personal loan options with a traditional financial institution without much hassle; those with less than perfect credit are being predominately served by the online lender market, although at a higher cost based on the applied interest rate.
Marketplace lenders do not focus on the subprime market, however. Their charm in the personal loan environment is based more on convenience and transparency than it is “easy” borrowing. Individuals seeking out personal loan options through online lenders will find simplicity in the application process, which for the most part is completed through an online portal. Additionally, online lenders tout fast decisions and short turnaround times for funding, making the appeal of a personal loan that much greater.
In addition to increased competition, personal loan growth is highly correlated to the low-interest-rate environment that has been in place since the start of the Recession. On average, banks and credit unions offer unsecured personal loans for as little as 5.75% without origination fees or funding charges. Similarly, online lenders offer rates as low as 5.99% in most cases, although some costs for providing the loan may apply. Compared to the double-digit interest rates on credit cards, personal loans with low interest rates remain a strong option for borrowers.
The Ideal Borrower
Although personal loans can be a smart financial tool for financing life’s major expenses, the product is not a fit for everyone. Most lenders, both conventional sources and online newbies, require borrowers to have a steady income and a history of repaying debts on time and in full. The lowest interest rates are made available to borrowers who fall into this category.
For subprime borrowers, personal loans may be available from some online lenders, but the interest rate charged for the duration of the loan is often high. Some marketplace lenders advertise personal loans with interest rates as costly as 36%, making the loan less attractive for the long-term. However, a personal loan can be a great way to build or repair poor credit history if you are able to find a lender willing to give you a second chance.
Anyone contemplating a personal loan, either for cash-flow needs or credit repair, should consider all the facets of borrowing in this manner. Personal loans provide a lump sum after approval is granted, and repayment begins shortly thereafter. Prior to taking on a new personal loan, you should ensure your monthly income supports the new loan payment for the entire term of your loan.
Alternatives to Consider
Taking out a personal loan might be a viable solution to cash-flow needs for some borrowers, but for others, alternatives in lending may be more appropriate. Both credit cards and home equity loans offer different advantages over personal loans, the most important being flexibility.
Credit cards are revolving accounts, meaning borrowers can use them at their leisure, up to the agreed upon credit limit. Minimum payments on credit card balances are far lower than monthly repayment obligations on personal loans, as they are calculated as either a set dollar amount or a percentage of the balance due. If you plan to carry a balance over from month to month on a credit card, however, you’ll need to be prepared for a much higher interest rate than you would find with a personal loan.
Home equity loans or lines of credit also offer some advantages over personal loans, but these borrowing options are only available to individuals who own a home and have accumulated equity in that property. A home equity loan works in a similar fashion to a personal loan in that borrowers receive a lump sum and accept repayment terms and an interest rate that are relatively steady for the life of the loan. However, home equity loans are available at incredibly low interest rates because they are backed by collateral – your home.
Home equity lines of credit work more like credit cards in that they offer flexibility in how much you borrow and how you repay. However, home equity lines of credit carry low interest rates compared to personal loans and credit cards, making them more affordable to homeowners. For both home equity loans and lines of credit, borrowers have the ability to receive much higher loan amounts than what may be available in the personal loan market.
Personal loans offer a variety of benefits to borrowers, including predictable repayment terms, a fixed loan amount, and for the best-qualified borrowers, a relatively low interest rate. However, personal loans are not the best option for every consumer. Homeowners may prefer the flexibility of home equity lending products in addition to the ability to borrow substantially more than a personal loan.
Credit cards offer a great deal of flexibility as well but are best used by borrowers who have a strong understanding of their ability to repay over time and the cost of carrying a balance over from month to month. As the personal loan marketplace continues to thrive, borrowers have ample options for securing the funding they need for their unique financial needs.
Author: Jeff Gitlen
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