In the last five years, the total dollar amount of personal loans in the United States has grown 132% from $46 billion to $107 billion. Personal loans are now the third most commonly applied-for types of credit, after credit cards and auto loans.
This tremendous growth has at least three interrelated causes.
The Improving Economy
Improved access to credit and economic growth tend to happen together. As credit becomes readily available, the economy improves. As the economy improves, lenders feel more confident about lending and borrowers feel more confident about taking on more debt. In the aftermath of the 2007 recession, credit was tightly constricted, even though interest rates were at record lows. As the economy improved, the credit spigots began to open and lenders cautiously began to make more unsecured loans.
The Alternative to High-Interest Credit Cards
As the first decade of the new century came to an end, mortgage rates remained at near-historic lows. Credit card interest rates, however, remained stubbornly high. The recession had left millions of people with damaged credit ratings. Credit card interest rates for those consumers ran as high as 29%. This created a market for a new kind of financial services company, called the fintech (financial technology) sector, that promised relief from such exorbitant interest rates.
The Rise of Fintech
Personal loans used to come primarily from banks and credit unions. But the rapid growth of e-commerce led to the invention of a new kind of lender, one that wasn't a bricks-and-mortar bank, but that existed wholly online. Once confined to back-end operations of traditional banks, fintech moved into the consumer world with the launch of internet-only banking and borrowing. Fintech companies made it possible to mortgage a house, borrow money for a car, and take out a personal loan without ever dealing with a conventional bank. What's more, those transactions could be accomplished online with minimum hassle or fuss.
This new finance industry also developed more sophisticated ways to weigh the risks and opportunities inherent in making unsecured personal loans. By looking at these advanced analyses, instead of just a credit score, fintech lenders were able to keep their costs down by reducing the number and size of loan defaults.
The Benefits of Personal Loans
Fintech companies made consumers a very reasonable proposal: pay off your high-interest credit cards with a lower-interest personal loan. And so today, consolidation of credit card debt remains the most commonly-cited reason for taking out a personal loan. This strategy doesn't always make sense, because companies that make personal loans often tack "origination fees" onto their loan terms. When added to the interest of a personal loan, such fees can make what looks like a way to save money on credit card debt a break-even proposition--or even a money-losing one.
One of the key benefits of modern personal loans is that they can be closed on very quickly. For people who face sudden emergencies or time-limited opportunities, a personal loan may be a better solution than a HELOC or other secured loan.
Moreover, personal loans may be the easiest type of unsecured loan to receive. Data from the Federal Reserve Report on the Economic Well-Being of U.S. Households in 2016 shows that 33% of all credit card applicants received at least one denial, but only 25% of personal loan applicants received at least one denial.
These benefits have driven the growth of the personal loan industry, which is expected to continue to expand in the next few years.
The Future of Personal Loans
No one really knows for sure what the financial markets will do in the years ahead, but many observers believe it is likely that the Federal Reserve will raise interest rates, which are now at very low levels. If that happens, the growth in the market for personal loans may begin to slow down. However, the vigorous competition within the fintech sector and between fintech and traditional financial institutions will continue to keep fees and costs down and eliminate the friction points involved in getting a loan. Readers who want to take advantage of these developments should check out our list of the best personal loan providers and compare rates and costs.