How online loans work, where to borrow (and avoid)

Online banking has become a few years, but online loans are slower to impress. Fortunately, there are a lot of good online lenders out there now.

Not only do you fill out the same old forms for your bank (which will be reviewed by a bank lending officer) – real online lenders are changing the way you lend.

The Benefits of Borrowing Online

How is an online lender different from the bank you’ve worked with for years?

The latest generation of lenders is focused on making it easy to borrow.

Quick approval: online lenders can tell you more or less instantaneously, whether approved or not, how much you can borrow and what your payments will look like. Most traditional banks are different: you’ll probably fill out an application online, but it may take a while to get an answer (someone might need to review the application, and you may need to visit a branch in person).

Better rates: It always pays to buy, and online lenders often pay less than you will pay elsewhere. You should see lower interest rates and lower service fees (if any). Only lenders on the Internet do not have the same costs as banks and credit unions with physical branches, and they do not face the same regulatory costs. In the end, it means you can pay less.

Banks and credit unions have been shaken up over the years

It’s easy to get a loan if you have good credit. But if you are still building credit or have been through some tough times lately, the standard FICO score will not do you any favors. Online lenders are more likely to approve lower credit scores and use “alternative” information to evaluate your credit (such as utility payments and even data from your social networks).

Unsecured loans: Most online loans are unsecured, meaning you don’t pledge collateral to get approved. This can make them more secure from borrowing from their property. If you do not repay the unsecured loan, your credit scores will fall (among other things), but your car will not be repaid and you will not face a write-off.

How to borrow

Getting a loan online is similar to getting a loan elsewhere – though it will probably be easier. You must provide personal information, such as your Social Security number and address. Depending on the lender, you will also need to provide financial information (such as information about your business and income, expenses and more).

To get started, just pick a lender and sign up. The process should take about 10-15 minutes. For ideas on lenders, read on.

Market lending

The best online loans come from non-traditional lenders. In other words, your local bank or credit union is probably not involved, nor are the big banks you hear about day-to-day work. New lenders are focused solely on making a particular type of loan. They do not want to offer checks and savings accounts, credit cards or business services.

The earliest lenders in this space were peer-to-peer (P2P) services, and they are still great lending options.

Lending Club and Prosper should be at the top of the list when purchasing loans online.

P2P lenders started with the “eBay for loans” model: anyone could apply for a loan by creating a public list asking for money, and anyone could borrow (borrow the interest rate they wanted to earn, with a loan funded at the lowest interest rates available). Over time, the system became more complex. In some cases, individuals no longer do lending – banks and other large institutions are a source of financing behind several prominent lenders in the market.

Although Lending Club and Prosper can be used for any purpose, newer loans try to lend to certain types of loans – and sometimes you will be better off matching your loan with your services. For example, it started doing student loans (and now mortgages, personal loans and more), while Good Finance and Good Credit do business loans.

Look for lenders, compare offers and go for the best.

Of course, you will want to research any lender to ensure that you are working with a reputable firm.

Avoid Payday Loans

When looking for online loans, you will find many results for loans that are essentially payday loans. These are short-term loans that are high costs that typically result in an expensive debt spiral. You can identify these loans (which you should avoid) in the following ways:

Very short deadlines: loans paid off are paid off within a month. Look for loans for which you can make monthly payments for more than a few years (and pay early with no penalties)

High interest or fees: again, buy. Payday loans will be drastically more expensive than market lenders. You can get a credit card and pay 20% APR, and many online loans charge significantly less. If you pay more than that, you will probably get a bad shipment.

No credit check: The fact is you need a decent (but not great) loan to get a decent loan. Anyone who lends to you without checking your credit risks – and they will expect to be compensated for the risk.

Prepay: Don’t borrow from one who offers online payment that requires prepay. Legitimate lenders may charge fees, but those fees come out of your loan income. Advance pay scams are notorious for asking you to hand over money and then not giving anything in return.

Bottom Line

To get a great loan, you have to shop, and internet lenders must be included in your search. Stick to reputable lenders and you should avoid problems.

Check with your bank while you’re at it, and go with the one that treats you best. Banks still provide valuable services and can help save you time (if not money) – but they are not always the best option for lending.