The ability to tap into a personal loan offer from an online lender gives consumers the advantage of quick access.
However, if you are weighing whether to go in for a personal loan online, there are other factors to consider that might outweigh the ease of access that online lenders offer.
“The growing comfort levels to conduct transactions online, as well as the ability to mine vast data resources to develop algorithms to predict a borrower’s credit risk have meant that we have seen a lot of new entrants into this marketplace,” says Tom Feltner, director of financial services with the Consumer Federation of America, a Washington, D.C.-based consumer advocacy group.
RATE SEARCH: If you’re looking for a personal loan, first check the offers on Bankrate.com.
In recent years, there has been a growth in the number of lenders offering these types of loans, such as Lending Club and Prosper.
Here’s what you need to know to get the best deal on a personal loan online.
Considering that these online lenders don’t face the costs that brick and mortar lenders typically face, theoretically they can offer consumers a good deal. However, it is not clear that they are passing on the benefits to consumers.
“It is too early to say that there are any advantages for consumers. There are clearly advantages for the disruptive Silicon Valley companies that are trying to eat the banks’ lunch,” says Ed Mierzwinski, consumer program director with U.S. Public Interest Research Group, a Washington, D.C.-based nonprofit consumer group.
That’s why you should read the terms of the loan contract carefully if you are contemplating personal loans, which many borrowers use for consolidating credit card debt. Because they are available online, these loans might appear to be simple and transparent, but they are not really so.
Although it is likely that the more creditworthy borrowers whom these lenders prescreen are offered good rates, that’s not always true.
There is a wide range in the interest rates associated with these loans. And considering that they may not effectively screen for ability to repay the loan, borrowers with less than stellar credit might find themselves falling into a debt trap if they are not careful, says Paul Leonard, senior vice president for federal policy in the California office at the Center for Responsible Lending, a nonprofit that fights predatory lending practices.
“The consequences for taking out a loan they cannot afford to repay will be manifold. They will default on their debt, they will fall back on their credit score and they will have to deal with collection agencies, and potentially wage garnishment,” Leonard says.
If the interest rates are high enough, the lenders will still benefit if borrowers default after paying even part of the loan. It’s best to shop around for rates.
Another area of concern is that typically these lenders set up the loan paperwork so that they can take advantage of an electronic debit directly from your bank account to periodically withdraw the money to repay the loan.
They do require your consent to set up repayments this way, but they also tend to provide incentives for you to go along with this. For instance, you might face a fee for each check you write, but you won’t face a fee with direct withdrawals.
However, once you set up your repayment with direct withdrawal, you won’t have control over the timing of the lender’s withdrawal and could find yourself surprised when you are looking to pay other bills and run into cash-flow problems.
You could even face difficulties if you decide that you want to end the lender’s access to your bank account.
Bank and credit card lenders typically use your credit score to determine whether you are a creditworthy borrower.
In the brave new world of online lending, data analytics also come into play. These lenders have access to so-called “big data” and draw up a borrower profile based on input, such as your use of social media and mobile devices, and use their own algorithms to qualify potential borrowers.
“If a creditor is screening its own customers and making offers, there are privacy problems because you don’t have the same rights you would if a credit bureau looked at your records. When a creditor buys a prescreened credit report to make an offer to a consumer, the consumer has rights,” Mierzwinski says.
“The consumer does not have the same rights when a creditor makes up its own score,” he says.
For instance, it is unclear whether the algorithms that online lenders use adhere to the Equal Credit Opportunity Act standards. It’s also unclear how algorithms, such as the number of Facebook friends you have, are indicative of your ability to repay a loan.
“This is new terrain for the regulators of this activity, and they are still getting their footing in trying to figure out how to best effectively regulate,” says Leonard of the Center for Responsible Lending.
RATE SEARCH: Taking out a personal loan is a big step financially. Check Bankrate.com for the best rates.
There also are other issues to consider with online personal loans. For one, be careful that you don’t apply for a loan through the website of a broker who generates leads for online lenders. These brokers develop marketing relationships with online lenders and will take the information you provide and broker it to the highest-paying online lender, Leonard says.
And considering that these online lenders have become more prominent since the Great Recession and as banks became more cautious about lending, these loans haven’t yet been tested through a downturn.
It is not clear whether the lenders will be amenable to any loan modifications if borrowers run into trouble. The loan contracts also might include a mandatory arbitration clause that prevents you from accessing the courts in case any issues arise with these loans.
“Be aware that there is no such thing as a free lunch. Be aware that just because a company can make a loan on your phone, it doesn’t mean it’s the best loan for you,” Mierzwinski says.
“Shop around, compare rates and terms. Don’t take the 1st loan that comes before you.”