Personal loans surge into mainstream
Rise of online lenders, lack of home equity fuel growth
If you're looking for a cheaper alternative to credit cards and aren't able to tap into equity in your home, you can join the surge of consumers who are powering the demand for personal loans.
In the two years that ended in the third quarter of 2015, the number of consumers with personal loans grew 18 percent, according to the a report issued Jan. 27, 2016, by the credit information bureau TransUnion. The report is titled "Consumer lending poised for growth in 2016."
In those two years, the number of consumers with personal loans rose to 27.3 million consumers, with $83 billion in unsecured loans and $165 billion in secured loans TransUnion found.
The demand for personal loans also has been fueled by the entry of online lenders into the niche. Some, such as SoFi and Avant, eschew brick-and-mortar locations and conduct their business online. Others, such as Lending Club and Prosper, focus on peer-to-peer lending.
"During and immediately following the Great Recession, consumer demand for both secured and unsecured personal loans grew," said Jason Laky, senior vice president and consumer lending business leader at TransUnion. "As new, well-funded online lenders and 'fintech' startups entered the market, personal loans had a broader appeal for consumers across all risk tiers.
They are far from alone in offering personal loans. Banks accounted for nearly 40 percent of the personal loans issued in 2014, and credit unions account for close to 30 percent, TransUnion found.
Discover, which is best known for its credit cards, also operates an online bank. It is aggressively using direct mail to market personal loans. Consumers apply for the loans online. PNC, which has more than 2,000 branches, is also pushing personal loans and allows consumers to apply online.
"The volume of mail and marketing is catching our attention," says Ezra Becker, vice president of research and consulting at TransUnion.
The volume of mail and marketing is catching our attention.
|-- Ezra Becker
How personal loans work
Personal loans are unsecured, which means you don't have to have collateral, such as a house or car, to gain approval, and they typically can be used for any purpose.
You usually borrow a certain amount of money for a set amount of time at a fixed interest rate. The rate you pay is based on your credit history and credit score. Your income and assets may also be taken into account. You may pay a lower rate if you already have a relationship with the financial institution from which you're borrowing.
While the most creditworthy customers may be offered an APR of 6 or 7 percent, rates for subprime customers may climb to 30 percent or more. On top of that, some lenders charge a loan origination fee.
TransUnion found the vast majority of loans are for five years or less, and loan amounts are typically for $10,000 or less.
Rates: More than a mortgage, less than a credit card
SoFi, one of the new online entrants to the personal loan market, entered the financial services sector four years ago, offering student loan refinancing. The company has added new products, including personal loans, based on consumer demand.
SoFi customers typically use personal loans to pay off unexpected costs, such as a wedding or a kitchen remodeling project, and are looking for an alternative to credit card debt. "They resent paying 15 to 20 percent for it," says Dan Macklin, vice president of community and member success.
At SoFi, customers pay fixed rates of between 5.50 percent and 9.99 percent APR if they set up autopay, or can take out a variable rate loan with a rate of 4.05 percent to 8.05 percent APR with autopay.
That's even lower than the average rate charged on personal loans. According to the Federal Reserve, a 24-month personal loan carried an average 9.98 percent APR as of August 2015. The average rate paid by credit card holders who were assessed interest was 13.59 percent APR.
It's a sharp contrast to mortgages, where the average 30-year, fixed-rate mortgage is currently less than 4 percent APR and federal student loans carry an APR of around 4 percent. Compared to credit card rates, "It's a bit of a mismatch," Macklin says.
The appeal of personal loans
Personal loans also are appealing, Boyle says, because consumers owe a set amount each month and can't run up higher balances. Often they're used to pay off expensive credit cards. Because they're installment loans, they are classified differently from credit cards in credit scoring formulas, and paying one off successfully adds points to your credit score because it adds to the "credit mix" category.
Another draw for personal loans is how fast they are to obtain. While it may take a month to get approval for a HELOC, online lenders will often give consumers a personal loan within a matter of days.
While personal loans have often been associated with subprime customers who don't have much access to credit, TransUnion found they're actually in demand among all types of consumers. While two-thirds of borrowers in 2014 were considered subprime or near prime, with credit scores of 660 or below, the number of consumers considered prime or higher has gradually increased since 2014.
SoFi targets its offers to consumers with good credit, strong earnings and low debt. "We wouldn't want to waste our money sending it to people who wouldn't be approved," Macklin says. It offers loans of up to $100,000, which is far higher than most companies that offer personal loans.
Often, consumers turn to financial institutions where they already have their money, says Ben Rogers, research director at Filene Research Institute, a think tank associated with the credit union industry.
Because loan amounts tend to be small, "it's rarely a cornerstone product," Rogers says, although most credit unions offer personal loans. They are particularly popular at small credit unions.
'A relationship product'
"This really is a relationship product," Rogers says. The value of personal loans granted at credit unions has climbed from $25.5 billion in 2010 to $32.2 billion in 2014.
It's unclear, though, how personal loans will fare over time, particularly with consumers with higher credit scores.
Becker says more creditworthy customers turned to personal loans when the economy tanked, home equity dried up, and HELOCs became a challenge to obtain. In 2009, about 1 million HELOCs were issued.
A report by RealtyTrac found that for the 12 months ending in June 2014, nearly 800,000 HELOCs were issued, up more than 20 percent from the year before, and the highest number since June 2009.
Because HELOCs tend to carry lower interest rates and are tax deductibles, consumers may shift back to them as their home equity continues to increase, Becker says.
The question, he says, is: "As home equity rises and as HELOCs come back into play, how is it going to impact consumer lending -- especially prime consumers?"See related: How a mix of types of credit helps your score
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