A couple of news stories from the weeks surrounding the LendingTree personal loan shopping launch illustrate how important it is to understand what you're getting into when you take on any borrowing. First up: New York's attorney general announced that he was suing an online lender which charged rates as high as 355 percent for personal loans. Generally speaking, that state's law caps the rate non-bank lenders can charge on small, unsecured loans at 16 percent.
Borrow $1,000, Pay $4,942
According to Reuters, the lawsuit alleges that in just two years, a $1,000 loan could cost a borrower $4,942 to repay when fees and interest were added. When The Los Angeles Times reported the story, it quoted Peter Holland, director of the University of Maryland's Consumer Protection Clinic: "It's a huge problem. It's very deceptive. It's very exploitative."
The second news story appeared on The Consumerist website on July 26, 2013. A 69-year-old Californian woman told the U.S. Senate Special Committee on Aging that she was turned down for a personal loan by the mega-bank where she'd been a loyal customer for many years. The reason given was that she wanted to borrow only $500, a sum below the threshold for this sort of borrowing. Instead, she was steered into a Direct Deposit Advance loan, which turned out to be little better than a payday loan.
Over the following five years, the woman had to renew the loan 63 times -- and racked up about $3,000 in fees. She would almost certainly have been hugely better off were she to have borrowed $1,000 -- twice what she needed -- in the form of a personal loan.
Choosing the Best Sort of Borrowing
So it's important to choose the best type of loan as well as a reputable lender. If you see an advertisement for "personal loans with no credit check" what you're really being offered is a payday loan or cash advance, most likely at a very high interest rate.
If you're a homeowner, you may get a better interest rate if you opt for a home equity loan, although you're then risking foreclosure if you miss your payments.
Another possible source of cheap finance may be your 401(k) account, either by taking a loan or by making a hardship withdrawal. But these too come with risks, as a recent survey (Loans and hardships can erode retirement savings) from Fidelity showed. Not only are you putting a chunk of your retirement savings on the line, but you may also find yourself becoming a serial borrower. On Aug. 16, The New York Times quoted Fidelity vice president Jeanne Thompson on the many people who repeatedly use these accounts in this way:
Once they broke the barrier, they went back and took more and more. They find it’s probably easier than going to the bank to get a loan, so it becomes a bad habit.
All forms of borrowing have their pros and cons, and the cheapest may not always be the best in the long term. If you decide that a personal loan is the smartest choice for you, try out LendingTree's new free service.