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Basics of a personal loan

Looking for a little extra cash? Some consumers who find they need a small amount to fix the car, buy a new washing machine or make a down payment on Junior's braces are passing up home equity loans or credit card charges in favor of small, closed-end, unsecured loans.


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"It's a growing type of loan," says Jane C. Yao, managing director for surveys and statistics for the American Bankers Association, a banking trade group. According to the organization's latest data, such loans make up more than one-fifth (22.1 percent) of the nonmortgage installment loans on the books at the nation's banks, up from 10.9 percent in 1998.

"It's a product that banks are finding a demand for in the market," says Yao.

In spite of that, unsecured loans are not that popular with banks, says Fritz Elmendorf, vice president of communications with Consumer Bankers Association. "It's not a very profitable product -- a $2,000 installment loan."

Instead, he says, the preference has been for credit card products. "It creates a lasting relationship with the customer," he says.

But using a credit card, which typically carries a much higher rate for a short-term loan is probably not the best option for the typical consumer, says Gail Hillebrand, senior attorney with the West Coast regional office of the Consumers Union of the U.S., publishers of Consumer Reports magazine.

"The problem is you need a lot of discipline to use a credit card as a loan," she says. "Pay the minimum payment and you won't pay it off for decades."

And treating the transaction like a loan, figuring out the payment needed to pay it off in a set time period, "is very hard for people to set up and maintain."

Shopping around
First things first. Decide how much money you really need. Better question -- what's the least amount that will get you through? And have you considered other alternatives to borrowing?

"Look at your credit situation already," says Hillebrand. "It's a good time to be cautious about taking out more credit. In this economy, most households have too much credit already."

Once you decide how much you need, start shopping. Use Bankrate.com's personal loan search engine to compare rates.

"Terms vary considerably," says Mike Schenk, vice president of economics and statistics for the Credit Union National Association, an umbrella group for the country's credit unions. "So it's best for consumers to shop around."

His advice: "Call around. Find out what the terms are. A lot of people might not think of financial institutions [like banks and credit unions.] Instead, their first stop might be a payday lender, and they have considerable rates."

Talk terms
So what kind of rates can you expect to see? Terms on two-year bank personal loans are averaging above 11.8 percent, according to the most recent (February 2004) numbers from the Federal Reserve.

But Hillebrand believes that credit unions might have an edge over banks when it comes to small loans.

"I would always start with credit unions," she says. "They have better rates and less abusive terms."

Ninety-six percent of credit unions offer short-term unsecured loans -- and more than half (60 percent) will make loans for amounts less than $500, according to figures from CUNA. The average amount borrowed is roughly $2,300. In addition, at least one-fifth of credit unions will make loans under $500 with just "a limited credit check," says Schenk.

If you're looking for a loan, here's a quick shopping list:

1. "Look at the total cost of the credit -- not just the monthly payments," says Hillebrand. And "a lower monthly payment is not always better."

2. Look for hidden charges. Study all the associated fees. Things to look for: credit insurance, buying clubs and any other extra fees. If you don't understand it, have the loan officer explain the charge. "Look at each of the itemized [charges] and ask about it," she says.

3. And finally, if what you're being told by the loan officer is different from what's in your contract -- walk. Once you sign, promises from a loan officer, who may or may not be working at the institution next week, are meaningless. What counts is what's in writing.

And when it comes to loans, bigger is not always better.

Sometimes, loan officers will try to talk borrowers into taking a little more money than they had originally planned, says Hillebrand. That may be because the officer gets a commission based on the loan amount (more likely at a finance company) or because state regulations are looser for larger loans, she says.

In her home state of California, "regulations are tougher for loans under $2,500," she says. Bottom line: "If they try to upsell you on credit, be cautious."

In addition, some institutions may handle unsecured loans by proffering credit cards. But credit cards are a different situation entirely for borrowers. Often, rates are not fixed and may change during the course of the loan. And credit cards are revolving credit, meaning the borrower and lender don't set a fixed period to pay them off.

While that may sound like a great deal initially, it could be a lousy deal years later if you end up carrying a balance at 21 percent. Instead, opt for a specific loan amount with fixed monthly payments and a finite repayment schedule.

And learn from the experience. This might be the perfect time to sock away some money for the next rainy day.

"Think about opening a savings account at the same time," says Hillebrand. "The savings habit has to start sometime."

Dana Dratch is a freelance writer based in Atlanta.


-- Posted: April 29, 2004




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