- The three major credit bureaus in the United States rate your creditworthiness. If they deem that you have bad credit, it’s much more challenging to secure a loan.
- Personal loans are a tempting tool to help get cash that otherwise doesn’t exist in your checking account. If you have bad credit, personal loans will come with very high interest rates.
- Rebuilding credit and practicing healthy financial behaviors can be better options than taking out a high-cost personal loan.
According to the credit bureau Experian, nearly a third of Americans have a credit score of “Fair,” “Poor,” or “Very Poor.” Unfortunately, if you have a history of poor credit, you’ll find it challenging to get approved for loans.
Having a low credit score can impact your ability to rent an apartment, pay for car insurance, and secure a favorable cell phone service plan. It could also cause you to see higher interest rates on borrowing such as student loans, auto loans, and mortgages — if you’re able to even obtain a loan at all.
When people are in need of cash and have no assets to place as collateral, one of the things that they do is take out a personal loan.
People can obtain personal loans from financial institutions like credit unions, banks, and online lenders for almost any purpose — such as home improvement, weddings, medical or dental procedures, or even vacations. The purpose of the loan matters less than the creditworthiness of the borrower. Personal loans are typically short-term loans that have fixed monthly payments, with the loan terms lasting anywhere from two to five years. Like credit cards and student loans, they are unsecured loans, which means they are not backed by collateral. Instead, borrowers, secure loan offers based on their income and credit history. The loans can have annual percentage rates that reach as high as 36%.
If you have a bad credit score and have tapped out other sources of credit like credit cards, you’ll likely be seeking a personal loan. Is this your best bet? Today, we’re here to provide you with everything you need to know about personal loans with bad credit so that you can make a wise financial decision.
What Is Bad Credit?
There are three major credit bureaus in the United States: Experian, Equifax, and TransUnion. These companies compile credit histories for Americans, tracking things like loan applications and credit history and payments.
These bureaus also rely on what’s known as a FICO score. A FICO score is a three-digit number created by the Fair Isaac Corporation that measures your creditworthiness or the likelihood that you are going to repay a loan based on your credit history and many other risk factors. The FICO score scale is as follows:
- 800-850 = Exceptional
- 740-799 = Very Good
- 670-739 = Good
- 580-669 = Fair
- 300-579 = Poor
Lenders may also rely on another scale known as the VantageScore credit system. That scale is:
- 750-850 = Excellent
- 700-749 = Good
- 650-699 = Fair
- 600-649 = Poor
- 300-599 = Bad
When you go through the application process for a credit, lenders will run a credit check to look at your FICO score and credit history. Lenders look for things like how much debt you carry and whether you make payments on time when determining creditworthiness.
Generally, your payment history is the most critical aspect of the credit score, accounting for roughly 35% of the total score. Your credit utilization, or how much of your total credit you use, makes up about 30% of the score. Your length of credit history makes up 15% of the score. A healthy mix of accounts — credit spread throughout multiple types of loans and credit cards — makes up 10% of the score. New credit inquiries account for the last 10% of the score. These are general estimates only, as the credit bureaus have their proprietary ways of analyzing the riskiness of individual borrowers.
So, how does credit go bad? Not paying loans on time is a surefire way to tank your credit score. Having a credit utilization above 30% is also regarded poorly. You could also have a poor credit score if you just began building credit since lenders prefer to see a lengthy history. A score will also be low if you only have a couple of accounts. And, if you file a lot of loan applications and have lenders poking in your credit files often, your score will decrease.
Securing loans can become much more challenging with bad credit. Bad credit results in very high interest rates and charges. Lenders want to make sure they’re compensated for the risk that they take on by lending to you.
Personal Loans With Bad Credit
It’s possible to secure a personal loan with bad credit. In fact, there are lenders available who specifically offer bad credit loans. However, the interest rates on these loans will be sky-high. You may also be subject to maximum and minimum loan amounts. You may not receive enough funding to meet your goal, or you may be forced into taking on too much financing with a high interest rate.
Before starting the application process for a personal loan, consider the purpose of the loan and how this matches with the obligation you’re signing up for. Is taking out the loan a savvy financial move to help you pay down debt? Is it for a long-term purchase like an engagement ring, or a one-time pleasure like a vacation?
Taking out a personal loan can have long-term consequences. Preferably, the personal loan helps your financial situation and matches your near-term goals. If the loan is only going to add to your debt burden,this does nothing but add fuel to the fire and keeps you in what could be an endless pitfall of debt.
Personal loans could be a useful tool for debt consolidation, however. Debt consolidation means taking out one loan to pay off other loans so that you’re paying your debt off in fixed, monthly payments with the lowest interest rate possible.
Imagine you carry debt on a credit card with a 25% interest rate and a $5,000 balance. You have another credit card with a $3,000 balance also with a 25% interest rate. Then, you applied and qualified for a debt consolidation loan for $8,000 with a 20% interest rate. Taking out this loan allows you to pay down your high-interest debt with the required scheduled payments and provides you with a lower interest rate. If you’re going to go this route, also get a handle on the spending that resulted in the debt burden in the first place.
Things to Consider When Applying for Personal Loans
If you’re considering applying for a personal loan, consider these factors. First, consider rebuilding your credit if possible before applying for a loan. Doing so will allow you to attract better rates when applying.
If this is not possible, you must be diligent in comparing lenders for your personal loan. Just as responsible lenders will choose you carefully, you can also review lenders for their reputation and terms. There are a wide array of lenders available, ranging from banks and credit unions to online lenders like peer-to-peer lending sites.
Comparing lenders will help ensure you receive a favorable rate. It will also help keep you away from scams and predatory lenders. If you think you’ve found a lender, do some research to learn more about their reputation. The Better Business Bureau can provide you with an accurate depiction.
Also compare the annual percentage rates on the loan. APRs provide an apples-to-apples comparison of what you’ll pay in interest and fees with different lenders. Check the fine print of these loans to learn about any upfront and ongoing costs, as well as the repayment terms.
Lastly, you may want to consider if a personal loan is worth it in the first place, especially if you’re struggling to overcome a poor credit rating. You may be better off waiting to borrow and working to improve your overall financial health and building excellent credit.
Remember that improving your credit report takes time. Here are a few suggestions that can help:
- Strive to live within what you earn, and don’t spend money unless it’s already in your bank account if possible.
- Factor in what additional or revised payments will do to your cash flow. A simple budget plan would help.
- Work hard to pay down debt, especially on loans that come with high interest rates.
- Read up on what you need to do to get rid of debt and build good credit.
- Understand how credit card interest works and the compounding effect that it has.
Improve Your Financial Health
Personal loans may be tempting, but they can carry high risk to your financial well-being if they add to an already heaving debt burden. If you absolutely must secure a personal loan, proceed with caution. Unsecured personal loans come with high interest rates, especially if you have poor credit.
Be sure to research all of your loan options and compare things like APR to determine the total cost over the life of the loan. You are the best judge of whether taking out a personal loan if necessary, whether it’s the right solution for you, and what loan amount you can realistically afford to repay.