What are loans for bad credit?
Loans for bad credit are a type of personal loan available to borrowers with poor credit scores and histories. These loans are designed for people who need access to financing but have difficulty qualifying for traditional loans from banks and credit unions due to low credit scores.
The purpose of bad credit loans is to provide funding for those with damaged credit who would not otherwise qualify for financing. They allow people with poor credit to borrow money for expenses like debt consolidation, emergency costs, home repairs, medical bills, auto repairs, and more. These loans usually have higher interest rates and fees compared to traditional loans, reflecting the increased risk taken on by lenders.
Bad credit loans may also be referred to as subprime loans. They are marketed to borrowers with FICO credit scores below 640. Some key features of these loans include:
- Available from online lenders and storefront payday lenders
- Typically range from $300 to $5,000
- Can be unsecured or secured loans
- Have higher interest rates than traditional loans
- May require a credit check
- Repayment terms often shorter than traditional installment loans
While bad credit loans present borrowing opportunities for those with less-than-perfect credit, they can be expensive and should be used cautiously. Thorough research and comparison shopping is important to find the best rates and terms. Improving credit scores over time can open up more affordable borrowing options.
Why Do People Need Bad Credit Loans?
There are a few key reasons why borrowers with poor credit seek out bad credit loans:
Reasons for Poor Credit
Many people find themselves with poor credit due to financial hardships like job loss, medical expenses, or other unforeseen circumstances beyond their control. A history of late payments, collection accounts, and other negative items can significantly damage credit scores. Those with limited credit histories may also have trouble accessing affordable financing.
Emergency Expenses
When an urgent expense arises, like a car repair or medical bill, those with poor credit often have few places to turn. Friends or family may not be able to help, and traditional lenders are likely to deny applications for those with low credit scores. Bad credit loans provide funds to cover emergency costs when there are no other options.
Limited Options
People with very low credit scores usually cannot qualify for credit cards, personal loans, or other standard financial products. Even high-interest subprime lending typically requires credit scores of 550-650. For borrowers with scores below 500, bad credit loans may offer the only path to getting necessary financing. These loans make it possible to access funds that would otherwise be unavailable.
Types of bad credit loans
There are several types of loans available for people with bad credit. Understanding the differences can help you choose the best option for your situation.
Payday loans
Payday loans provide fast cash, usually $500 or less, that is repaid on your next payday. These short-term loans have very high interest rates, often $15 to $30 per $100 borrowed. Payday lenders don’t check your credit. The approval process is quick, making them convenient when you need money fast. But it’s easy to get trapped in a cycle of debt by rolling over loans with new fees each pay period.
Title loans
Title loans use your car as collateral. The lender will give you a percentage of your car’s value, often 25% to 50%, in cash. Title loans have to be repaid quickly, usually within 30 days or less. The interest rates are high, often more than 200% APR. If you can’t repay the loan, the lender can take your car.
Installment loans
Installment loans provide a lump sum of cash that is repaid in fixed monthly payments over a set period of time, usually 6 months to 5 years. These loans can be secured with collateral like a house or car or unsecured. Installment loans have lower interest rates than payday or title loans but higher than conventional bank loans.
Peer-to-peer loans
Peer-to-peer lending connects borrowers directly with individual investors rather than a bank. You apply for a loan online and investors choose whether to fund all or part of the loan request. Interest rates can be better than traditional loans for bad credit, but approval and funding rates are lower.
Secured and unsecured loans
Secured loans require an asset like your home or car as collateral that can be seized if you default. This allows lenders to take more risk. Unsecured loans have no collateral, so they carry more risk for the lender and often have higher interest rates. Both options are available for bad credit borrowers.
Pros and cons of bad credit loans
Taking out a loan when you have bad credit can be risky, but it may also provide an opportunity to rebuild your credit score. Here are some of the key pros and cons to consider with bad credit loans:
Pros
- Easy approvals: Bad credit lenders are often more likely to approve applicants than traditional lenders. This gives people with poor credit access to financing they may not be able to get elsewhere.
- Chance to rebuild credit: Making on-time payments on a bad credit loan shows credit bureaus you can responsibly manage debt. This can gradually improve your credit score over time.
Cons
- High interest rates: Bad credit loans typically have much higher interest rates, often in excess of 20%. This is to compensate the lender for taking on riskier borrowers. You’ll end up paying far more in interest costs.
- Potential debt traps: Some predatory lenders target those with bad credit and set unrealistic repayment terms. If you can’t afford the payments, you may end up worse off than before.
- Aggressive collections: Those with bad credit are more at risk of aggressive collections practices if they default on a loan. This creates additional stress and damage to your finances and credit.
When weighing bad credit loans, it’s important to consider both the potential benefits and the significant risks and costs involved. Improving your credit first through secured credit cards or credit builder loans may provide a less costly path. But if you need immediate financing, bad credit loans present an option if used carefully.
Interest Rates and Fees
Bad credit loans typically have much higher interest rates and fees compared to loans for borrowers with good credit. This is because lenders view bad credit borrowers as riskier to lend to. The higher rates and fees help mitigate the increased risk.
The most important rate to look at is the APR or Annual Percentage Rate. This factors in both the interest rate and any origination fees or other charges, providing the true cost of borrowing over a year. APRs on bad credit loans can range from about 15% up to 36%, with an average around 25%.
Origination or application fees are usually 1-6% of the loan amount. These fees cover processing costs and reduce risk for the lender. Late fees are also common, often $15-30 for each late payment.
Some bad credit lenders also charge prepayment penalties if you pay off the loan early. This fee is usually around 1-3 months of interest. Paying off the loan faster saves on interest, but the penalty offsets that savings for the lender.
Carefully reviewing the rates and all fees is essential when comparing bad credit loan offers. The lowest APR should be the priority rather than just the lowest nominal interest rate. Fees can greatly increase the true cost of the loan.
Improving your credit score
One of the best things you can do if you have poor credit is to work on improving your credit score over time. This will give you access to more loan options with better terms in the future. Here are some tips for improving your credit score:
Make on-time payments
Payment history makes up a significant portion of your credit score calculation. Try to make at least the minimum payment on all your bills by the due date each month. Setting up automatic payments or payment reminders can help ensure you don’t miss any due dates and hurt your score. If you have any late payments already on your record, continuing to make on-time payments can help offset those over time.
Pay down balances
Keeping credit card balances and other revolving debt below 30% of the credit limit can also help boost your score. Pay down high balances aggressively if possible, while still making minimum payments on all other debts. Reducing your overall utilization can demonstrate responsible usage of credit.
Seek credit counseling
Non-profit credit counseling agencies can provide advice tailored to your situation on managing debt, dealing with creditors, monitoring your credit reports, and improving financial habits. They may be able to negotiate lower interest rates or other concessions. Participating in a debt management program through a credit counseling agency could help organize your payments.
By monitoring your credit reports, making payments on time, keeping balances low, and addressing any errors or issues, you can rebuild and improve your credit over time. Having a higher score can open up better loan options in the future. Be patient and persistent in adopting habits to boost your credit health.
Alternatives to Bad Credit Loans
While bad credit loans provide access to funds, they often come with high interest rates and fees. Before taking out a bad credit loan, consider some alternatives:
Borrow from Family or Friends
Borrowing money from family or friends may be an interest-free way to get funds in a pinch. However, approach these requests carefully to avoid straining relationships. Consider drafting a loan contract outlining repayment terms. Treat the borrowed money professionally by making regular payments and express gratitude for their assistance.
Credit Union Loans
Credit unions may offer personal loans, auto loans and credit cards to members with poor credit. Interest rates from credit unions are typically lower than payday lenders or other subprime sources. Credit union underwriting can be more flexible than traditional banks. Build your relationship with a credit union by becoming a member, making regular small deposits, and taking out and repaying a small loan first.
Secured Credit Cards
Secured credit cards require a cash deposit as collateral for the credit line. The deposit amount becomes the credit limit. Charges, payments and interest accrue like a regular card. Making on-time payments helps rebuild credit. After about a year of responsible use, the card may graduate to an unsecured card and the deposit is refunded. This allows access to credit without a credit check.
Applying for a Bad Credit Loan
When applying for a bad credit loan, there are a few key requirements you’ll need to meet:
Minimum Credit Score
Most lenders will require a minimum credit score between 500-600 to qualify for a bad credit loan. The higher your score is within this range, the better your chances of approval and the lower your interest rate will likely be.
Some specialty lenders may approve loans with credit scores below 500, but you will pay much higher rates and fees. On the other end, those with scores above 600 may qualify for more mainstream personal loans at better rates.
Income Requirements
Lenders need to see consistent income to ensure you can repay the loan. Many will require monthly income of at least $1,200-1,500 or annual income of $15,000-$20,000. Proof of income through pay stubs, tax returns, or bank statements is typically required.
Self-employed individuals may qualify by providing business tax returns, 1099 forms, or proof of contract work. Retirees may use retirement account statements or Social Security award letters.
Application Process
Applying for a bad credit loan will require:
- Basic personal information (name, address, Social Security number, date of birth)
- Employment details including income verification
- Bank account and routing numbers if you want funds directly deposited
- List of personal references and contact information
- Details on the loan amount and purpose
Many lenders allow you to complete the entire application online. You’ll get an instant initial decision, then complete documents may be required to underwrite and verify your information.
The lender will do a hard credit check which could temporarily lower your score by a few points. But timely repayment of a bad credit loan can actually help rebuild and improve your credit over time.
Comparing bad credit loan offers
When applying for a bad credit loan, it’s important to compare offers from multiple lenders to find the best rate and terms. Here are some key factors to compare:
Compare APRs
- The APR (annual percentage rate) is the total cost of the loan expressed as a yearly rate. This includes the interest rate plus any fees.
- APRs on bad credit loans can range from 5% to 36% or higher. Always compare APRs, not just the headline interest rate.
- Look for the lowest APR to reduce the total cost of borrowing. Sometimes a loan with a higher interest rate but lower fees will have a lower APR.
Compare fees
- Loans for bad credit often come with fees like origination fees, application fees, late fees and prepayment penalties.
- Ask lenders to disclose all fees upfront. Factor these into the APR when comparing offers.
Compare loan terms
- Loan terms like length, payment amounts, payment schedule, etc can vary between lenders.
- Make sure you can afford the monthly payments on the term offered. Shorter terms often have higher payments but lower interest costs.
Compare lenders
- Look at reviews and complaints for lenders you’re considering. Avoid lenders with many negative reviews.
- Compare factors like customer service, ease of application, and transparency. Find a reputable lender you feel comfortable working with.
Taking the time to compare all the costs and terms will help you get the most affordable bad credit loan for your situation.
Managing and repaying bad credit loans
Taking out a loan when you have bad credit is a big responsibility. It’s important to manage the loan properly and repay it on time to avoid further damaging your credit. Here are some tips:
Budgeting
- Create a budget to allocate funds for your loan payment each month. Account for the total monthly payment including interest and fees.
- Avoid taking on additional debt while repaying your loan. Adding more credit obligations can overextend your budget.
- If money is tight, look for areas to cut back on discretionary spending. Prioritize essential expenses first.
- Build an emergency fund with 3-6 months of living expenses. This provides a buffer if you face a financial hardship.
Pay on time
- Mark all payment due dates on your calendar. Set up automatic payments or payment reminders if it helps you pay on time.
- If you anticipate an issue making a payment, contact your lender immediately to discuss options. Don’t wait until after you miss a payment.
- Pay at least the minimum due each month. Paying late or missing payments can drastically lower your credit score.
Credit impact
- Monitor your credit report and score. On-time payments will start to gradually improve your credit over time.
- If you continue missing payments, your lender can send your account to collections. This damages your credit score severely.
- Defaulting on a loan stays on your credit report for 7 years. Get back on track with payments to start rebuilding credit sooner.
Consolidate debt
- If you have multiple high-interest loans or credit cards, consider consolidating into a single loan with lower interest. This can simplify payments.
- Debt consolidation loans still require good credit. If your credit is poor, focus on paying down debts one by one.
- Be cautious of balance transfer offers. They seem attractive but often have high deferred interest if not fully paid off.
Making on-time payments and keeping your debt low will help improve your credit over time. Be disciplined and patient. Bad credit can recover if you actively work at it.
Top 10 Proven Ways to Earn Cash Without Leaving Your House In 2023