What is a Bad Credit Loan?
When we refer to bad credit loans, we're talking about loans for people who are trying to borrow money, but they have a low credit score. Another common scenario for bad credit loans is for people who have not yet had an opportunity to build a substantial credit history.
As you can imagine, people with low credit scores or thin credit history can have a tough time obtaining a personal loan, but there are options.
Traditional banks, online lenders, and credit unions provide loans to individuals with poor or unestablished credit. However, it's important to note that whether or not a borrower is considered “creditworthy,” depends on the lender.
What is a bad credit score?
A FICO score that falls between 300 and 629 is typically considered bad credit. However, a low credit score does not instantly disqualify you from obtaining a personal loan.
Some financial institutions have more rigid requirements than others, making it essential to thoroughly shop around when searching for a loan if you’re currently rebuilding your credit.
In fact, there are online lenders that work with consumers with poor credit and realize that there is more to your borrowing ability than a credit score. Loan companies like these consider your credit history and credit score when reviewing your application, but their requirements are often less stringent than traditional banks and they may be willing to take other factors into consideration as well.
If you have a low credit score, or haven't been able to borrow enough money to get a solid credit rating, you might find yourself in the market for a bad credit loan.
Types of Bad Credit Loans
If you have bad credit and want to obtain a personal loan, there are two main choices available: secured and unsecured.
Secured loans require collateral, which usually will mean tying your loan to your house or your car. This is typically a good option for consumers who don’t qualify for an unsecured loan but own an automobile or have equity in a house. Better terms, higher loan limits, and more favorable rates are often associated with secured loans, as they are viewed as less risky than loans for which no collateral is given.
If you’re confident that repaying the loan will not be a problem, this is an option worth considering. If, on the other hand, you're concerned about the possibility of defaulting, it is not wise to put your collateral at risk.
As the phrase implies, collateral is not necessary for an unsecured loan, and it is your creditworthiness that determines the rate you receive. Because unsecured loans do not require collateral, they are usually associated with lower loan limits and higher interest rates. For those with low credit scores, the terms of this type of loan might not be ideal, but some consumers have no other alternative.
Finding a lending institution that offers bad credit loans seems like it would be easy, but there are quite a few out there. Instead of weeding through the internet and filling out multiple forms, we’ve pulled together a few options that could be a good fit for your individual needs.
Bad Credit Loans Online: How the Process Works
Filling out an application for a bad credit loan online is not very different from applying for a traditional loan. Legitimate lending institutions usually consider your credit history, as well as your ability to repay the loan and other factors concerning your current financial situation.
Regardless of your circumstances, it’s important to understand that in the eyes of lenders, you may be seen as a risk if you have a low credit score. For this reason, you may end up paying sizable finance charges, fees, and high-interest rates. In certain cases, the cost of the credit can be as much as $20 per $100 of loan. Of course, this is not always the case, but it is a possibility.
Early termination fees may apply as well, so it is essential to research all the fees associated with any loan you are considering so that you have a thorough understanding of the ultimate cost of the credit.
Acquiring a Bad Credit Loan
Review Your Credit Report
Before applying for a personal loan or line of credit, make sure you view your credit report and deal with any errors negatively impacting your score. If you correct errors and manage to push up your credit score even a few points, you may increase your odds of being approved, as well as possibly obtain a lower interest rate on the loan.
Once a year, you can request a free credit report from each of the three major reporting agencies, TransUnion, Experian, and Equifax.
Consider Applying at a Credit Union
Personal loans from trustworthy online lenders are convenient and quick; however, local credit unions offer a personalized service and in some cases, lower interest rates. Eighteen percent is the maximum APR offered at most federal credit unions.
If your local credit union turned you down for a loan, you should shop around online to see if you prequalify for a loan with an online lender.
If you fill out an application, the timeframe when applying for a loan can be as short as 24 hours and as long as seven days. A hard credit inquiry is completed during the process. This is something that may temporarily negatively affect your credit score, so you don’t want to do it with an excessive amount of lenders, but if you make your personal loan payments in a timely manner, your credit should rebound shortly.
Top Short-Term Loans for Bad Credit
As the name suggests, short-term loans are associated with financing of a short duration. Loans of this type must typically be paid back within a week to six months. One example of this type of loan is a cash advance loan, which is usually repaid in a single lump-sum that includes finance charges, interest, and the principal loan amount.
The total amount of a short-term loan is typically lower than the amount for a long-term loan.
Other Loan Options for People with Bad Credit
Installment loans are repaid with interest in equal monthly payments over the life of the loan. The payments include an amount toward the principal of the loan, plus interest and any other applicable fees.
Payday lenders do not base your eligibility on your credit report, but they do charge exorbitant interest rates for the loans they provide. These loans are usually for smaller amounts, typically $500 or less, and the terms are of short duration. You should be prepared for extremely high fees associated with payday loans as well.
The Consumer Financial Protection Bureau discovered that the average cost of a two-week payday loan is the equivalent of a 400% APR. Some states have banned payday loans entirely and others have placed limits on payday loan fees and amounts.
Cash Advance Loans
Cash advance lenders usually don’t check your credit either, and these loans work best for those with a steady income or a credit card. For example, if you have a credit card that is unsecured, you can often take a cash advance from the issuer. The interest rate on this transaction is sometimes much more favorable than the other options available, and it does not involve a hard pull of your credit report.
Short Term Bank Loans
Depending on your bank’s requirements, you may be approved for a short-term loan or minimal overdraft agreement. Qualifying for this arrangement depends on your ability to maintain an open account and your history with your bank.
Be on the Alert for Bad Credit Loan Scams
Unfortunately, borrowers with bad credit are sometimes targeted for scams. However, there are some overt signs you can watch for to determine whether or not a company is legitimate. Below are some red flags that may indicate a scam:
- The company is not registered in your state: Lenders are required by the Federal Trade Commission to register their financial institutions in the state in which they conduct business. Lenders that are not registered are probably not legitimate.
- Guaranteed approval: Trustworthy lenders virtually always pull your credit report, and ask for additional information prior to extending a loan offer. You may find yourself in a bad situation if you do business with a lender who has no interest in your credit history. Always consider it a bad sign if the lender is not concerned about your credit rating.
How to Manage Your Personal Loan
Whenever you take on debt, such as a personal loan, you should have a plan to pay it off. The tips outlined below will help you manage your loan:
Include Your Loan in Your Budget Plan
Design a budget that separates your income into multiple categories, allowing money for needs and wants, as well as some for savings. You should also factor in your debt to your monthly budget to ensure that your personal loan payments are made on time.
Communicate With Your Lender
Contact your lender immediately if you fall behind on your loan payments and try to work out a strategy to catch up. Certain lending institutions offer hardship programs or help you get back on your feet by temporarily suspending your payments.
Build Credit by Using Your Loan Wisely
Naturally, the most effective way to guarantee better financing options in the future is to begin building good credit as soon as possible. Whether you are using a credit card, or have applied for a short-term loan or installment loan, making timely payments improves your credit rating.
- Set your loan payments up on an automatic withdrawal through your bank. This eliminates the burden of you having to remember due dates and will help you avoid late fees. Creating a consistent repayment pattern keeps you in good standing with creditors.
- Cash in, cash out: Try to come up with a strategy to pay for most of your purchases in cash rather than charging items and accruing credit card debt. If you’re budgeting properly, you should never spend beyond your means, and using cash is a great way to keep track of your finances.
- Watch your accounts: Even when your spending activity is not high, check your credit card accounts and FICO score on a regular basis. This helps you to monitor your spending, stay in mental control of your finances, and prevent annual fees from creeping up on you unexpectedly.
- Take a look at our guide to credit repair for additional strategies that will help you find your way back to excellent credit.
The Bottom Line on Bad Credit Loans
Having to start over financially is something that happens to many people for a variety of reasons and is nothing to be embarrassed about.
Not being able to pay off debt, inadequate resources, and a lack of knowledge can all negatively impact your credit score– but do not forget, that bad credit is reversible. You can still build good credit and take charge of your finances, and a bad credit loan is a viable tool that may help you to do just that.