Why fintech and personal loans could add up to trouble
Americans are once again digging themselves into debt. Unsecured personal loans reached a record high of $138 billion last year. This borrowing boom is fueled in part by marketplace lenders in the fintech sector—the world of digital technologies that deliver financial services to consumers. Fintech accounted for 38% of all personal loans in the U.S. last year, up from only 5% in 2013.
What exactly are marketplace lenders? Rather than offer loans themselves, they simply “connect consumers or businesses who seek to borrow money with investors willing to buy or invest in the loan,” explains the Consumer Financial Protection Bureau. This model is often referred to as “peer-to-peer lending.”
Recently, though, the line between marketplace loans and traditional ones has blurred, said Christopher Peterson, a senior fellow at the Consumer Federation of America. “Because peer-to-peer lending never took off, at least in the United States,” he said, “marketplace lending” has come to encompass some pretty old-fashioned loans as well. While sites like Lending Club and Prosper still use the peer-to-peer model, big-name banks are now getting in on the game. The one thing they all have in common: They’re quick and easy enough to do on your phone.
If you’ve ever thought about borrowing money through one of these platforms, hit pause and read on to understand what you should be wary of.
Benefits of marketplace lending
Applying for a loan using a website or app from a marketplace lender can be simpler than sitting for an in-person interview with a loan officer. And some marketplace lenders may be reaching out to populations who’ve been overlooked by traditional lenders.
For example, some of these platforms “use alternative data sources, such as utility bills and predictive information” to judge prospective loan recipients, writes Jennifer Pryce, an investment executive, in Forbes. This opens the door for people without strong credit scores or a lot of assets to get loans, if they have enough income.
Dangers of marketplace lending
The sudden growth of this sector has raised eyebrows. Observers wonder if the industry can survive an economic downturn, given that some lenders target higher-risk borrowers.
For everyday borrowers, the downsides include upfront fees and interest rates that range from 6% to as much as 36%—the same dangers consumers should be looking out for when applying for any kind of loan or line of credit, Peterson said.
And applying for a personal loan online might just be too easy. The simplicity of the process increases the temptation to seal the deal without thinking it through. Before you borrow, ask yourself a few questions:
- Why do I need it? Is the loan for something you can put off, like a home improvement project or a pricey vacation? If so, make this a savings goal, rather than piling on costly debt. If you’re borrowing for something pressing, consider the terms carefully to make sure it makes financial sense. For example, if your aim is to consolidate or pay down high-interest credit card debt, consider a balance transfer card instead, or at least make sure the interest rate on your personal loan will remain lower than that on your card.
- How is your cash flow? How much can you realistically spend each month on loan payments? Use this limit to help determine the size of the loan you should ask for. As with a home loan, don’t ask for or accept a bigger amount than you need, or than you can afford to pay back.
- Have you done your due diligence? Whether you’re looking at marketplace lenders or old-school banks, you’re going to want to compare lenders. Check the interest rate—is it variable or fixed? Read the fine print about any fees or penalties, including origination or processing fees, late fees, or prepayment penalties that dock you for paying down the debt quickly. (Yes, some lenders charge these.) Compute the total you’ll be paying over the life of the loan. Try NerdWallet, Credit Karma, and Bankrate to compare the terms of various lenders. Finally, think outside the bank. “Seriously consider going to a nonprofit credit union,” Peterson said. “They’re not always better, but they may have a little better terms than for-profit lenders.”
The world of marketplace lenders is new and changing. Don’t be seduced by a slick app or website. But the basic concerns for borrowers are not radically new: It always pays to tread carefully.