There’s no getting around it: We live in a society where debt is the norm. The United States owes more than $18 trillion, and individual Americans are following in Uncle Sam’s footsteps, racking up more than $11.9 trillion in personal debt for mortgages, credit cards, and loans for cars and education.
Though it’s much better to live without debt than with a stack of bills showing how much your assets are in the red, there can also be times when you have to spend money you haven’t budgeted for. And instead of putting all those expenses on a credit card with interest rates that look like they were devised by Scrooge, plenty of Americans are planning to take out a personal loan instead.
According to a recent Bankrate study, 24 million Americans (about 10% of the entire population) are very likely or somewhat likely to take out a personal loan in 2016. To get a sense of what that means and who are the best candidates for such a loan, The Cheat Sheet talked with Todd Albery, CEO of Bankrate-owned Quizzle, a site that uses information like your credit score and credit report to advise you on which financial products might be a good fit for your financial situation and goals – including personal loans.
About 27 million Americans already have a personal loan of some kind, Albery said. The fact that about 10 million Americans are very likely to get a personal loan this year and another 14 million are considering it shows the personal loan market is expanding, he said.
What is a personal loan?
Personal loans are unsecured forms of debt, meaning they’re not backed by collateral such as your car or your home. They’re set up with a fixed repayment plan, such as 12 to 24 months, and have a fixed interest rate so you know the full cost of the loan ahead of time. You can get personal loans through a traditional bank, but other sites like Prosper and Lending Tree allow peer-to-peer lending, where people can enter how much they’d like to borrow and for what purpose, and individual investors can put up the money, getting a return on their investment with the interest rates.
Peer-to-peer lending is a relatively new concept, and was met with some skepticism early on, at least in part because they’re Internet platforms and a completely new way to borrow money. But as a number of new companies have joined the space in the past few years and the original companies have had a chance to prove themselves, Albery said the structure is becoming more established.
Interest rates on personal loans are higher than traditional loans that have some sort of collateral. However, with rates starting as low as 5.5% for people with good credit (the average is about 11.3%, Bankrate reports), they’re a better alternative for quick purchases than putting charges on a credit card, which often have interest rates starting at around 15.6%.
Personal loans for emergencies, credit cards, and weddings
A combination of favorable market conditions and a need for quick money contribute to the rise in personal loans, Albery said. For one, there’s less risk with personal loans right now – or at least the appearance of less risk. Federal interest rates remain low and unemployment is also low, meaning it’s a less risky climate for investors backing loans. Conventional wisdom says that while people are working, they’ll be able to make payments on time and won’t default on their loans.
On the other side of the equation, borrowers are facing a number of expenses, but have slightly more confidence in the economy than they did a few years ago, Albery said. They’re willing to spend more on home improvements, weddings, or travel because they’re confident they’ll be able to pay off any expenses they incur.
One reason personal loans are becoming so popular is because about 30% of Americans don’t have an emergency savings fund, Albery said, and they need a loan when they’re faced with a car payment they can’t afford all at once, medical bills, or an unexpected home repair. “Those kinds of things can stress the debt out a bit,” he said.
Should you be saving for emergencies? Absolutely. But if you find yourself stuck, signing up for a personal loan can be a better financial decision than putting all that debt on a credit card, without a specific plan for paying it off.
Emergencies aside, Albery said that about 80% of personal loans are used for debt consolidation, often for credit card debt. A lower interest rate on one bulk loan can help you pay off the cards immediately, and then pay off the personal loan over a set period of time. Most times those loan payments come from your bank account automatically, so you also don’t have to worry about making payments on time, Albery said.
Though many millennials are debt-averse, about 18% of people ages 18 to 29 are somewhat or very likely to take out a personal loan this year, the Bankrate study found. In some cases it will likely be for those emergency savings, especially since younger people haven’t had the same amount of time as their older contemporaries to save for those inevitable budget hiccups. In others, it’s a way to pay for big-ticket items like a wedding or travel without putting it on a credit card, and establishing a set payment period ahead of time, Albery said.
Who should consider a personal loan?
Personal loans aren’t for everyone. In some cases, using a home equity line of credit will yield better interest rates. You’ll be borrowing against your loan and likely working with a traditional bank, Albery said, but the rates are often lower than that of personal loans. If you’re determined to pay off your credit cards within a year or so, using a credit card balance transfer is another strategy to consider. However, you’ll want to make sure you can truly pay it off, because otherwise monthly interest rates will skyrocket after low introductory rates expire.
Of course, having zero debt is preferable to dealing with outstanding bills in your financial ledger. If you can avoid home repairs for a bit or save up for emergencies ahead of time, that will always serve you best. But if you do find yourself in a situation where you’ll be going into debt anyway, personal loans are becoming a larger viable option. At the very least, the set payment plan ensures you have a strategy for paying off the debt, Albery said, instead of letting it linger on a credit card statement and potentially growing into a monster you can’t control.