If you’re one of the roughly 42% of Americans with bad credit or no credit, it may seem as though you’re stuck in a bottomless pit that’s impossible to escape. You may feel helpless when trying to secure a personal loan or that credit lenders aren’t giving you a fair shake based on your credit history.
Whether you’re looking to pay college tuition, buy a car, or purchase a home, bad credit can make things much more challenging.
Fortunately, if you have poor credit, there are some things that you can do to secure a personal loan. Below, we’ll take a look at what lenders consider to be “poor credit” and provide you with tips on how to get a loan with bad credit.
The Big Ideas You’ll Learn
- What is considered poor credit and how it can make it challenging to secure personal loans for buying a car or paying for school.
- There are short-term options available for those with bad credit. But, it’s important you take the right steps to protect your long-term financial health.
- Steps you should follow before taking out a loan to ensure you don’t end up trapped in debt.
What Is a Credit Score and How Is It Used by Lenders?
One recent study found that a quarter of millennials don’t know what a credit score is. If you’re wondering how to get a loan with bad credit, it’s imperative that you first understand how the credit rating system works and how lenders define bad credit.
Your credit score is a number ranging between 500 and 850 that lenders use to determine your creditworthiness — or how much risk they take on by lending you money. There are three major credit bureaus in the United States: Equifax, Experian, and TransUnion. Each bureau provides you with a FICO score or VantageScore.
Each credit bureau values different types of information when determining ratings, so don’t be surprised if your score differs slightly across each. For instance, one bureau may be concerned about your credit utilization, otherwise known as the percentage of available credit that you use. Another may be more concerned about whether you make monthly payments on time.
When you go to secure a personal loan, lenders will pull your FICO score or VantageScore and credit history from the bureaus to perform a credit check. Your credit score and credit history will determine not only if you can receive a loan, but the interest rates you’ll receive on the loan.
Typically, lenders consider the general ranges when defining credit scores:
- 750-850: Excellent Credit
- 700-749: Good Credit
- 650-699: Fair Credit
- 550-649: Poor Credit
- 300-549: Very Poor Credit
What Constitutes Poor Credit?
If your FICO score is less than 579 or your VantageScore is less than 549, lenders will consider you to have poor credit. When a lender sees a bad credit score, they will be worried that you won’t be able to make loan payments on time or that you won’t repay the entirety of the loan in full.
Furthermore, having no credit is practically the same as having a low credit score. Because you don’t have any credit history, lenders have no way of knowing whether you can fulfill the loan terms.
Short-Terms Ways to Secure a Loan With Bad Credit
Improving your credit score could take years. If you need access to capital right now, time is not on your side. If you have bad credit, consider some of these methods that you could use to secure a loan in the short term.
Secure a Government-Backed Mortgage
If you need a mortgage, one of the first things you should consider is a government-backed loan. The United States government does not offer these loans directly. However, they “back” the loans, promising to pay them off were you to default. Three of the most common government-backed loans include:
- U.S. Department of Veterans Affairs loans — VA loans are for active service members, veterans, and their spouses looking to buy a home. There is no technical minimum credit score required, although many private lenders often elect to institute a minimum.
- Federal Housing Administration loans — FHA loans are typically designed for lower income individuals with lower down payments and credit scores. 3.5% down payment required, so long as your credit score is above 580. If it’s below 580, the required down payment is 10%.
- U.S. Department of Agriculture loans — The USDA loan is for those moving to rural areas. Most lenders require a minimum credit score of 640, although they do have flexibility to make exceptions for unique circumstances.
These loans typically help ensure low closing costs, low down payments, and lower interest rates. So long as you meet the criteria, these loans could be an incredible option if you have bad credit.
Rely on a Credit Union
If you need to secure a personal loan, you could consider going to a credit union. Whereas banks are for-profit financial institutions, credit unions are nonprofit entities. The NCUA Board, that oversees credit unions in the United States caps interest rates charged on personal loans received from credit unions at 18%. Banks do not have this cap and are more likely to quote you a loan with high interest rates, taking advantage of your poor credit.
Credit unions also tend to have more flexibility in who they lend to. Banks typically evaluate only credit history and credit score when determining your creditworthiness.
In contrast, credit unions can consider things such as your character or your history in paying rent or utilities when determining your loan options. If you have a poor credit score that’s the result of bad luck or hard times, a credit union could be more sympathetic to your case and provide you with a favorable loan offer. You’ll need to provide information such as proof of income and access to other liquid assets, such as your bank account or savings account. But, doing so will allow credit union lenders to view the whole picture, not just a mere snapshot, increasing your chance of getting approved.
Have Someone Co-Sign the Loan
If there is a friend or family member who you trust — and who trusts you — you could have them co-sign your personal loan. Co-signing a loan provides credibility if you have a bad credit score.
Note, you won’t want someone to co-sign your loan if they too have poor credit. You should search for a trustworthy, established debtor who can provide credibility to your loan application.
Consider Other Loan Options
If you cannot secure a traditional loan, you may want to consider other loan options that are designed explicitly for people with bad credit.
Second-Chance Installment Loans
One such example is a second-chance installment loan, which offers things such as credit leniency, flexible loan amounts, favorable loan terms, and support beyond the loan. Borrowers must repay installment loans through a series of monthly payments throughout the life of a loan.
Smaller financial institutions are typically the ones providing these loans, and are often willing to do so for amounts as low as $500. Big banks usually do not offer short-term loans, especially to those with poor credit.
These loans could also be attractive to those with no credit, as lenders will account for things such as whether they paid rent, cable, and utility bills on time. These factors typically don’t show on traditional credit reports. Those receiving a second-chance loan will likely also see low interest rates and access to resources that improve the likelihood of future financial success.
Bad Credit Loans
Some lenders cater specifically to borrowers with poor credit by offering bad credit loans. These lenders tend to have more flexibility in their underwriting requirements and can look at factors beyond just your credit score and credit history (such as housing history). A bad credit loan typically does not exceed $5,000, but they can give risky borrowers access to cash quickly as the funds can often be received by the next business day.
Other Loan Options for Poor Credit
You could also look into short-term loans. The rates on these loans typically expire within six months. Lastly, you could think about a payday loan, which is a short-term, unsecured loan similar to a cash advance. You’ll need to provide proof of income and should expect high interest rates.
What to Do Before You Take Out a Loan
Be Deliberate and Thoughtful
One of the most significant mistakes that people with bad credit make when searching for a loan is they become desperate. They make a rash decision that provides them with access to quick capital, but they may take out a loan they can’t pay back or that costs them so much they go into debt. Make sure you shop around from various lenders, and don’t settle on the first offer you receive.
Understand the Cost of Debt
We generally recommend that you do everything possible to stay away from high interest rates in your loan agreement — specifically, you should try to avoid anything with an interest rate higher than 5.5%. What you’ll pay in interest could have otherwise gone toward a savings account or paying debt.
However, sometimes things happen and you may need to take out a loan with high interest, particularly if you have bad credit. If you’re in that situation, it’s important to know the true cost of that loan.
For example, the difference between a 5% interest rate and a 25% interest rate on a five-year loan is more than $20,000. On a 10-year loan, the difference exceeds $102,000. The chart below further demonstrates how devastating high interest rates are.
Therefore, before taking out a high interest loan, make sure you do the math to understand how much that loan is really costing you. Then, do everything in your power to pay down that loan as quickly as possible.
Don’t Apply for Credit Frequently
Another point worth emphasizing is that each time a lender runs a hard credit check, it can ding your credit report. So, if you have bad credit, your goal should not be to submit as many loan applications as possible. Instead, you should be strategic about how you apply for credit. Doing so will increase the likelihood of being approved for a personal loan.
What to Do Now That You Have a Loan
Securing a loan with bad credit is no sure thing. Practicing sound personal finance behaviors will go a long way toward building your credit score and improving your chances of securing a loan in the future.
Avoid Late Payments
Upon securing a loan, you should make sure that you avoid late payments. In addition the cost of the late payment fee, a payment late by 30 days could drop your credit score by up to 110 points. This increases the cost of any future borrowing you may do in the future. Similarly, demonstrating that you can make on-time payments is one of the best ways to help improve your poor credit score, which could save you money overtime.
Understand Your Credit Score and How to Improve it
In order to improve the likelihood that you can get a loan or to reduce the cost of borrowing in the future, it’s important to understand what hurts or helps your credit score. There are a number of good habits that can help you, but below are the biggest drivers:
- Pay your bills in full and on time.
- Keep your credit utilization (or your balance of debt owed divided by your total credit limit) below 30%.
- Keep old credit cards (if you have any) open as they increase the average age of your credit.
- 1 in 5 Americans have an error on their credit report, so check your credit report for errors and report errors to the credit bureaus.
Consider Debt Payment and Consolidation
Another crucial financial behavior is debt consolidation and payment. Debt consolidation involves rolling multiple debts into a single amount with a favorable interest rate. You can consolidate debt through a personal loan or credit card. Combining debt can reduce your interest rate payments and make it easier to pay down debt.
If paying debt on multiple accounts, make sure that you pay down your loans with a high interest rate first. For instance, imagine you must make $100 payments each month on two loans — one with a 10% rate and one with a 20% rate. You have $250 at the end of the month to put toward debt. You should pay the minimum payment on the 10% loan, and put the remaining $150 toward the loan with the higher interest rate.
Open a Credit Card (and Use It Wisely) to Build Credit
If you don’t have a credit history, you may be looking for ways to build your financial reputation and reliability. One of the best ways to do so is by opening a prepaid or secured credit card. There are numerous cards available for first-time borrowers, such as the Discover It and the Capital One Mastercard, among others.
Just be sure to use make smart decisions and use it like a debit card. Ideally, pay your balance each month so you’re not racking up credit card debt while trying to build credit.
Securing a Loan Is Possible With Bad Credit
If you have bad credit, it’s possible to obtain a loan. Make sure when doing so, you practice sound financial behaviors, and you don’t engage in anything that is going to harm your credit score in the long run. By following these steps, you can escape the endless cycle of debt while improving your credit score and financial health.