The article below on online loans is for informational purposes only and should not be construed as financial advice.
Hell is not other people. Hell is waiting an excessive amount of hours in a stuffy bank, only to be told that your loan application is filled out wrong and that you need to go back to the end of the line. Frankly, the lollipop at the end isn’t even worth it anymore.
And so the market said, “Let there be online loans!”
Money is scary. That’s why we’re here to help. We’re going to give you the low down on online loans: what are they, when do you need them, and what do you feed them to make sure they don’t get cranky?
Whether you’re trying to reduce credit card debt, cover an unexpected cost, or consolidate existing loans into a single, manageable payment, the struggle to protect your personal finances is real. Understanding the power of online loans at the beginning of your career will generate huge impacts on your financial fitness in the long-run. They often create opportunities for people who can’t or don’t want to turn to old-school sources like banks.
In order to qualify or get a good rate, traditional lenders require you to have a pretty extensive credit history, which most young people by default don’t have. Online lenders are challenging this approach and using new datasets like education or job history to expand financing opportunities. At the same time, they are making it much simpler and faster to apply for and get a loan.
So get ready: you are about to understand online loans like never before.
How loans usually work
Before jumping into all the secrets of an online loan, let’s first understand the basics of how loans work.
So there’s this guy, Bill. Bill needs some money to pay broker fees on his new apartment. It’s a pretty big amount to pay up front and he doesn’t have the cash now, though he will over time as he gets paid at his new job. Unfortunately, the broker is not willing to take bagels as payment, so Bill must figure out a way to get this money today. Bill talks to Jenna, who is willing to give him money for a short time. Bill promises to pay it all back.
Bill is the borrower. Jenna is the lender. The amount that Bill borrows is called the “principal.” (Not to be confused with the scary bald administrator of your elementary school.)
But that is not all. Jenna is going to charge Bill “interest,” and maybe some kind of upfront fee for borrowing the money.
Generally, there are two main types of “interest” and two main types of interest “rates.” The two types of interest are:
- Simple interest
- Compound interest
Simple interest means that Jenna is only charging Bill interest on the principal amount that Bill still owes her.
If she instead charges compound interest, then she is charging Bill interest both on the principal and on the unpaid interest accrued thus far. Compound interest usually means more interest paid over time.
Now, there are two main types of interest “rates”: fixed and variable.
- A fixed rate stays the same over the life of the entire loan. What you see is what you get. This allows you to “lock in” your monthly payment for the entire term of the loan.
- A variable rate can change. When certain economic situations change, your interest rate might even go up! When your interest rate goes up…so does your monthly payment.
Not understanding how interest accrues and how rates work could cause you to pay more in interest than you even borrowed initially. That’s not great for your financial fitness. We can’t emphasize this enough: pay close attention to the rates.
#protip: If you’re curious about what a fixed rate (simple interest) loan could look like for you, play around with this loan calculator.
Why the traditional approach doesn’t work
Until recently, almost all personal loans came through large, established financial institutions such as banks and credit unions. It is notoriously difficult for people with limited credit histories to gain access to these sources of financing at reasonable rates (if at all).
A credit score is basically a grade used to determine your creditworthiness. Credit reporting agencies take into account a range of information such as timely payment of credit accounts and length of credit history. Lenders take credit scores seriously, using them to approve or deny applications and to determine how much interest to charge.
The problem for countless people at the outset of their careers is not that they have bad credit history. Rather, they lack credit history altogether. If you’ve recently graduated from college, you probably haven’t been using a credit card regularly or making payments on a house. While you don’t have any “bad” history, you don’t have any good history either. In the traditional, FICO-only based approach, you’re guilty until proven innocent.
But there is hope! If you can’t get a traditional loan, or don’t have time to deal with the byzantine application process and paperwork, numerous alternative online lenders have started incorporating different metrics to assess creditworthiness. These lenders are creating amazing opportunities for people without credit history, who also need swift and simple access to capital.
How online loans are fixing the problem
Online lenders have addressed the weaknesses of traditional lending in two ways:
- They have made the process simpler and faster,
- They have started using variables in addition to FICO to better serve borrowers.
First, being web-based allows online lenders to process applications very quickly. Compared to traditional lenders, which take weeks to approve an application, most online lenders can give you a decision in minutes and have the funds to you in days. With Upstart, you can check your rate in 2 minutes. If you like what you see, completing your application requires just a few more minutes (and possibly uploading a document or two). Once your full application is processed and approved, you can get your funds the next day!1 If you choose to, you can also make payments easy and automatic through the borrower dashboard.
Second, some online lenders have started to use non-credit variables to determine creditworthiness. The most sophisticated companies incorporate additional information such as borrowers’ academic record, work experience, or test scores to create a more holistic view of a potential borrower’s creditworthiness.
For example, Upstart is pioneering the use of underwriting with academic variables. To date, we’ve underwritten more than $300 million in loans to over 30,000 borrowers.2 We excel at serving individuals with limited credit history.
Basically, we believe that if you worked hard at school or at work, then you’ve earned access to a better rate than a bank would offer. Our approach is more forward-looking: instead of focusing on what your credit has been in the past, we look to what your potential will be in the future.
What you can use online loans for
Online loans can be used for a number of purposes. Here are a few of the most common:
1. Refinancing: update your existing loan terms
If you want to refinance, or update your loan terms, online loans are a great place to start.
People explore refinancing when either their personal or broader economic situation has changed and their loan terms aren’t working for them anymore. You can refinance to change your monthly payment, interest rate, or total life of the loan.
For example, let’s say that the monthly payment has become too much for you to pay. You might refinance to make the loan term longer or try to get a lower interest rate so that you can afford your payments.
Or maybe your credit score has gone up because you were making so many great payments on all of your bills! If you’re now eligible for a lower interest rate, you might consider refinancing to save money.
#protip: Make sure you’re really weighing the tradeoffs here. You might benefit from a lower monthly payment, but if refinancing comes at a higher cost either upfront or in greater interest payments over the life of the loan, then it’s probably not worth it.
2. Debt consolidation: make one easy payment
Having to keep track of numerous payment cycles, bills, and creditors is a nightmare. You don’t get paid until the 15th, but your credit card payment is due the 12th. Your checks always take a few days to fully deposit into your account, but your car payment is due tomorrow. Wait, but what about that utilities bill? When is rent due again?
If your finances are tight, a few days can make a painful impact on your accounts in fees and interest – not to mention your credit score if you have to make late payments. You already have so many things to juggle in your head – make it easier with debt consolidation. Debt consolidation allows you to compress several debts into one loan with one interest rate and set of terms. It makes repayments simple. If you graduated college with a bunch of debts, it might be a great time to consolidate so you can focus on getting your career started.
3. Important life purchases or self-investment
Aside from handling debt, online loans are a hassle-free way to finance other large life purchases. This could be anything from an apartment broker fee to car repair or online classes. The loan goes out to you and you get to decide how to spend it. Spend wisely!
How online loans can help you
You have to admit that there is an adrenaline rush to doing something official in your pajamas, like applying for a loan. Besides not having to actually leave your bed to apply, online loans offer many advantages.
First, the alternative approach that many online lenders use to evaluate creditworthiness might give you access to credit and financing that you couldn’t get through traditional sources. They can be particularly helpful for people who do not have a lengthy credit history. Many of our own borrowers share stories about how they tried applying for a loan at a bank or credit union, but were constantly rejected until they applied through Upstart.
Regardless of your credit history, having more options can help you make the best decision about your loan. You can easily compare rates and terms from multiple lenders online, to ensure that you are getting the best terms.
Lastly, speed is a huge priority in our fast paced lives. With Upstart, you can get a rate in a flash by just providing your basic personal information. Depending on how quickly you type, it could be less than two minutes!
What you need to know when shopping for online loans
Here are the key factors you should keep in mind when shopping for an online loan:
- The interest rate of the loan (how much is borrowing this money costing you?)
- The time you have to pay it off (how long will you have the loan for?)
- How quickly you get the money (will the process be completed within the timeline you need?)
- Any additional fees or restrictions
Before choosing a loan, always do your homework. You don’t want to end up with a payment you can’t actually afford. Not being able to make the payments could worsen your credit score, which will further disadvantage you in the future.
#protip: some lenders pull a hard inquiry on your credit report when you apply, which can dock your credit score by a few points. If you’re just shopping around or comparing rates, try to limit your search to those who will only conduct a soft pull at application (which does not affect your credit score). FYI when you do finalize the loan, most lenders perform a hard check before sending the funds.
Jump start or reset your life
Whether you just need a little oomph to start off your career, or a reset button to undo some earlier financial mistakes, online loans can put you on the right track.
Take some time to do your research and shop around. When you’re ready, know that there are many options available for you.
1If you accept your loan by 5 PM ET (except weekends and holidays) you will receive your funds the next business day. Education-related loans are subject to a mandatory 3-day waiting period, following the applicant’s acceptance of the loan terms.
2More than $300 million and 30,000 loans have been originated through the Upstart platform as of June 01, 2016.