Consumers facing an unexpected need for cash may have several options -- home equity financing, borrowing against or withdrawing from retirement savings, selling assets, taking cash advances from credit cards, or requesting loans from family or friends. For many, though, personal loans are the best choice -- there's no collateral required, they can be underwritten and funded very quickly, and the entire process can take place privately online if the applicant wishes.
However, personal loan interest rates can vary a great deal, which makes shopping and comparing lenders more important.
Why Personal Loan Rates Vary So Much
Personal loan interest rates vary a great deal -- considerably more than mortgage rates. There are several reasons for this:
- The personal loan market is more fragmented.These loans aren't bought and sold by investors through huge clearinghouses like Fannie Mae and Freddie Mac, so lenders don't have to conform to guidelines established by giant corporations.
- Personal loans don't have the same government oversight that mortgages have. That means personal loan lenders don't have to abide by rules set by the VA or FHA.
- Personal loans are unsecured, which means there is no property for the lender to take if the borrower defaults. A mortgage lender might be on the hook for 20 percent of the loan amount, while an unsecured lender could lose 100 percent of the balance. Therefore, the interest rate is affected more by differences in borrower credit scores than secured financing -- applicants with bad credit are riskier and must pay a lot more.
Personal Loan Credit Grades
Personal loan interest rates depend a great deal on the credit grade assigned to the borrower. Here's an example dated Augist 16, 2014 from one Delaware-based lender. Annual percent rates (APRs) range from 6.63 percent for A-rated borrowers to 36 percent for those with poor credit. ,
While shopping and comparing quotes from different lenders is important, the most effective method for paying less interest on an unsecured, signature or personal loan is to improve the credit rating. However, for someone with an emergency cash need, that's not necessarily practical.
Comparing Personal Loan Interest Rates
Borrowers should know what their credit scores are before shopping for personal loans. That way they can compare interest rates for loans in their credit grade. Consumers can obtain their credit reports for free from the government's site www.annualcreditreport.com each year (other "free" credit report sites require credit monitoring and want a credit card number before providing the report). In addition, they can get a Free VantageScore from LendingTree's Money Center with no obligation and no credit card number required.
Each lender has its own credit grading structure and its own pricing schedule. Some are more forgiving than others for people at the bottom, while others lavish their love on prime borrowers but charge much more to those with credit issues. The credit grade also impacts the amount that may be loaned and the length of the term offered.
Because the markets are so fragmented, consumers may have to spend more time searching online for programs than they would for a mortgage or auto loan. The search can pay off, however. Here's another set of rates from a West Coast lender:
By comparing just two lenders, once can see that borrowers at different grades are not treated the same way. For example, someone at the top tier could pay an APR of 6.63 percent for a three-year loan with the Delaware-based lender but would get 7.95 percent with the Pacific-based company. However, the West Coast outfit charges 21 percent for the lowest tier applicants while the East Coast lender wants 36 percent. In addition, the first lender adds a much higher premium for longer terms than the second one. Each lender caters to a different group of borrowers and prices accordingly.
Make Comparison Easy
One easy way to compare rates and terms is by using online marketplaces like LendingTree. Applicants answer a few easy questions and can then peruse offers at their leisure. After selecting the offer with the most agreeable terms, they can simply contact the lender by phone or click to apply online. The money can be theirs in a matter of days or hours.