Yet in recent years a new form of debt has quietly gained ground as startups and online lenders found means to offer a new service: easy-to-get personal loans.
Between the third quarter of 2013 and the third quarter of 2015 (the most recent data available) is the number of consumers with personal loans in the United States grew by 18% to 27.34 million, according to the credit reporting agency TransUnion.
Above 10% of 1,000 American adults Bankrate, the private finance company polled in January, said it would either be “very likely” or “very likely” to take out a personal loan in the next 12 months. And about 20% of adults who said they were considering this were between 18 and 29 years old.
There are several reasons young adults are thinking more about personal loans today than in the past.
For one, very few have savings in an emergency fund; about 63% of adults indicated they had no emergency reserves for unexpected events such as a $ 1,000 emergency room visit or a $ 500 car repair.
“As soon as one of these life events occurs, be it a medical emergency, repairing a car, getting a new car or renovating your home, it can suddenly be a trigger that pushes someone over the edge,” said Todd Albery, general manager from Quiz game, a bank rate company that provides services including free credit reports.
In the past, those without emergency funds may have turned to credit cards, but in recent years online personal loan providers have attracted attention, especially after several companies like LendingClub and Prosper raised significant funds. LendingClub LC,
, which raises money from outside investors and lends it to individuals, became the first peer-to-peer lending company be publicly traded in December 2014.
Earlier this week, JP Morgan Chase & Co. JPM,
agreed to acquire Nearly $ 1 billion in LendingClub personal loans that experts said are a sign of health for the online personal loan market.
“That trust and investment support legitimized this market,” said Albery.
Until online lenders became popular, the process of obtaining a personal loan was “painful and arduous” and involved a personal visit to a bank. Also, not all banks offer unsecured personal loans that allow borrowers to take out a loan without tying it to another asset like their home, said Al Goldstein, CEO and co-founder of Avant, a three-year-old personal loan provider based in Chicago.
The average loan amount Avant makes is $ 8,000, Goldstein said, with terms between two and five years; Since the company was founded three years ago, Avant has issued more than 450,000 loans, Goldstein said. But the interest rates can be steep: Depending on the creditworthiness and location of the borrower, they range from 9.9% to an upper limit of 35.9%. According to Goldstein, 90% of Avant’s customers make their payments on schedule.
According to a study by Bankrate, 80% of personal loans go into debt consolidation, Albery said. Many consumers are tempted by the idea of simplifying their debt and only making one payment a month, especially when they can automate the payment and not damage their creditworthiness from accidentally missing payments, he said. (Of course, this only makes sense if the personal loan interest rate is lower than the student loan, credit card, or other debt that would be consolidated).
The rest is for larger purchases, from vacations to cars to home improvement projects.
In some cases, it makes more sense to seek out a personal loan than to put those charges on a credit card, Albery said. Personal loans can enable consumers to use less of their credit limits; the inclusion of a high percentage close to one’s own limit has a negative effect. For example, if you use more than 30% of the credit card usage (the amount you borrow compared to the card’s total limit), it will have a negative impact on creditworthiness. Also, paying compound interest on credit cards can cause credit card debt to spiral out of control.
And for millennials who are used to making a loan payment due to student loans, especially online, taking out a personal loan is not as uncomfortable as it was with previous generations.
“A credit card is not a personal loan” said Beverly Harzog, a consumer credit expert and author of “The debt escape plan. “Even with cards with an APR of 0%, it is not possible to spread payments over several years, so many consumers appreciate the structure of a personal loan, she said.
There are, of course, considerable risks associated with this.
To be approved for a personal loan in the first place, a consumer must have a high credit score, Harzog said, which means it may not be an option for many people. She recommended that you see several personal lenders before choosing the best one and read the fine print carefully; sometimes lenders charge fees for a variety of reasons, including penalties for repaying the loan faster than agreed.
Anyone considering a personal loan should set up a budget to make sure the payments fit into all of their other monthly bills, said Chantel Bonneau, an asset management consultant for Northwestern Mutual who works with Millennial clients. She warns against borrowing money for discretionary spending if it can be avoided.
Paying interest between 6% and 12% on discretionary debt is high but not catastrophic, she said; with higher interest rates it is “very difficult” to wipe out the debt.
In a pinch, especially in the event of a health emergency or family tragedy, there are a few other options online that you can at least try, including the charity crowdfunding websites You care or GoFundMewhere those in need can set up their own fundraising pages and others can donate to their cause.
Saving money in an emergency fund and investing in disability insurance are smart ways to avoid a desperate situation, Bonneau said.
“Most of these things would be prevented if people took the time to do financial planning.”