How personal loans work and how to get one

With credit cards canceled and limits cut, consumers may be looking for new ways to get through the holiday shopping season, cover an emergency expenditure or consolidate their high-interest credit card debts. One alternative might be personal loans, offered by banks, credit unions or even companies typically considered credit card providers.

These loans are unsecured -- meaning that no collateral, such as a car or a house, is required for approval -- and come at a fixed interest rate and are in place for a fixed term. That's the biggest advantage to borrowers over credit cards: Personal loan terms don't have some of the "tricks and traps" federal regulators have associated with credit cards, so you won't face a ballooning monthly payment or skyrocketing interest rate. And, in most cases, they can be used for whatever purpose the borrower desires.

"We usually have a tick-up in requests around tax time and the back-to-school period," says Scott Pellegrini, consumer lending product manager at Addison Avenue Federal Credit Union, based in Palo Alto, Calif.

Personal loans are risk-basedAddison Avenue, like many other financial institutions, rely on risk-based pricing -- looking at a consumer's credit score and credit history to determine interest rates, which vary from person to person.

In recent months, personal loans have been gaining traction as a means to pay off higher-interest debt. "Across the board, I think people are looking to consolidate debt and get out from underneath it," Pellegrini says.

Wells Fargo, headquartered in San Francisco, has had success with its "Debt Pay Down Solution," introduced in late 2007 and marketed strongly since late 2008, says Brent Vallat, senior vice president and business manager for personal credit management.

Consumers are able to use the Wells Fargo Web site to calculate how long it will take them to be debt-free. The site helps them examine their budget and offers suggestions as to how they can save on expenses. It then offers the option to use those savings to more quickly pay down debt.

Interest rates vary by state and length of the loan, and as Wells Fargo assimilates former Wachovia Bank locations, the product will be introduced to those customers as well.

Vallat compares customers who have embraced the plan to those who "got religion. They're very passionate about it. This is a really disciplined way to take control of debt."

Not just for banks anymoreIt's not just banks and credit unions that have such products. USAA, best known for offering insurance products to military members, offers an unsecured personal loan of up to 48 months with an annual percentage rate as low as 12 percent for customers with an excellent credit history.

"It's truly no strings attached," says Joseph "J.J." Montanaro, a certified financial planner with San Antonio-based USAA. Customers can use it to pay off debt or make purchases, as they see fit.

Sometimes, personal loan solicitations can come from surprising sources. A recent mailing from Discover offers personal loans of up to $25,000 and allows consumers to choose the amount they'd like to pay back each month, as well as the length of the loan.

Rates range from 7.99 percent to 18.99 percent, depending on a person's credit risk. If someone receives a $10,000 loan at 7.99 percent,  they may choose to pay anywhere from $313 a month for 36 months to $175 per month for 72 months.

Mike Berg, a magazine editor in Westwood, Calif., took advantage of a similar offer from Capital One last year when he needed to sell his condominium "in a really bad market" because of a job move, and was underwater on his mortgage.

He used a $30,000 personal loan from Capital One with a 7.99 percent APR, as well as personal savings, to avoid a short sale on the condo and make up the difference between the unit's deflated sales price and what he and his wife still owed on the property. "There were no hoops. It was an easy solution."

Berg received the offer because he is a Capital One credit card customer, and within about 10 days of filling out the paperwork, he had a check.

Some are scaling back loansBecause of the current economic climate, Capital One, based in McLean, Va., has scaled back its personal loans, only offering them at their brick-and-mortar locations in a handful of states, says spokeswoman Pam Girardo. Rates now range from 10.49 percent to 17.95 percent, with loan lengths ranging from 24 months to 84 months.

While Capital One and Bank of America have halted their direct mail solicitations for personal loans, others are still going strong. During the third quarter of this year, 80 million solicitations were sent out, says Andrew Davidson, senior vice president of Mintel Comperemedia, a direct marketing research firm which has its U.S. headquarters in Chicago.

Of those still sending out personal loan solicitations, Citibank tops the list, with a 20 percent market share, followed by Discover, with a 14 percent share. While no credit union has more than a 1 percent to 2 percent market share, many have "very competitive offers," Davidson says.

A study done for the Filene Research Institute, a think-tank backed by the credit union industry and located in Madison, Wis., found that a 36-month unsecured consumer loan offered by banks had an average APR of about 13.8 percent, while credit unions averaged about 12.1 percent.

According to a Citi spokeswoman, the bank's average personal loan is for $8,000, with an average interest rate between 15 percent and 16 percent. She said some people opt for personal loans rather than credit cards because "some consumers like the discipline of set terms."

A double-edged swordWhile an unsecured personal loan can be a good way to pay off higher-rate debts, it can be a double-edged sword. "It's another debt you have," USAA's Montanaro says.

Ryan Himmel, a certified public accountant in New York, says whether a person should apply for a personal loan all depends on their plans for the cash. It's one thing if the consumer wants to make an unnecessary purchase; it's another if it's used to pay for something needed.

A consumer should ask herself: "What is the loan for, and how do I plan to pay it off in the future," Himmel says. "If they don't ask, that's when they get into trouble."

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