In recent years the personal loan market has seen a surprising amount of growth, with the total number of consumers taking out personal loans growing by almost 30% (from 10.57 million to 13.72 million) between 2013 and 2015. Personal loans are seen as a relatively simple way to obtain money in the short term, and unlike credit cards, generally carry lower interest rates, with the average interest rate for a personal loan being 11.3% versus a rate 15.7% for credit cards. But despite the fact that personal loans have always been an option as a means of obtaining relatively cheap short term credit, the popularity of credit cards rendered personal loans all but forgotten until recently.
From Credit Cards to Personal Loans
Credit cards took over the unsecured loan industry when banks realized that consumers tended to spend more when they had a card in their hands (as many studies have shown) and that consumers paid less attention to credit card interest rates.
But personal loans, which are simple loans generally taken out over a short period of time and which aren’t secured by any type of property like a mortgage or car loan would be, have made a comeback in recent years for a variety of reasons.
First, since the subprime mortgage crisis, home value has declined which means taking out a loan against your home value is a less financially sound option. Furthermore, the economy, and more specifically the job market, have been steadily improving since the Great Recession leading to an increase in consumer confidence and willingness to take out loans. But perhaps most importantly, there has been a large growth in companies willing to provide such short term personal loans.
FinTech Companies Enter the Scene
The new batch of companies offering personal loans are mostly Silicon Valley style startups, such as Lending Club, which have been developing platforms to make securing loans from third parties exceedingly easy, especially for those with good credit. This sector, known as FinTech, has proven to be extremely lucrative; Lending Club recently went public with a valuation of $9 billion and there are several other private FinTech companies which boast valuations of over $1 billion. This sector is an extremely important force in the world of personal loans. Lending Club alone gave $8 billion in loans in 2015 which is close to 10% of the estimated $85.52 billion in total unsecured debt.
The Uncertain Future of Personal Loans
Despite the high profile valuations of FinTech companies, the current personal loan market has a very uncertain and possibly unhealthy future. Lending Club has continued to see rising delinquency rates in the past two years, leading them to both increase their interest rates as well as tighten their credit standards on two separate occasions in 2016 in efforts to continue to entice wary lenders. Unfortunately, the reason for this recent downturn may be endemic to the industry itself.
Observers have pointed out that many borrowers use personal loans to consolidate credit card debt but then, instead of closing the credit card account in question, continue to run up debt on that card, thus increasing their overall debt burden and making it harder to continue making payments. Furthermore, there is an information delay among companies offering these personal loans, making it easy for a borrower to take out loans from multiple companies at a time, a practice which can obviously have a dangerous effect on the person’s overall debt burden.
This may not be a disaster at the moment but if we experience an unexpected economic downturn in the coming years we’ll only see delinquency rates increase, potentially sending the young industry into a downward spiral of loan defaults. The fast growing personal loan market may end up just another part of the larger credit bubble, but only time will tell.