elenaleonova/GettyImages; Illustration: Hunter Newton/Bankrate
If you have bad credit, it can be hard to get approved for a loan. Luckily, if you can handle the high interest rates and payments, you can get a loan for bad credit from many lenders.
Before you apply, learn how bad credit personal loans work and what to expect to pay. Some bad credit lenders are predatory, and knowing how to spot them could help you avoid being exploited.
How do bad credit loans work?
The main difference between a bad credit personal loan and other personal loans is that the APR and fees are usually much higher for a bad credit personal loan, but otherwise it works the same way: you receive the full amount up front and pay back the balance plus a fixed interest rate every month for one to seven years.
What to consider when getting a loan with bad credit
There are many risks associated with personal loans for bad credit.
It will be more expensive because lenders will charge higher interest rates and fees, and they may also limit the amount of money you can borrow and the term over which you can repay the loan.
Bad credit loans are costly
A low credit score tells lenders that you may have had issues with late payments or defaulting on loans in the past. Lenders see a low credit score as a sign of higher risk, so they charge higher interest rates to ensure they make a profit. Interest rates on bad credit personal loans can reach 35.99 percent. For other types of bad credit loans, interest rates can be even higher.
A higher interest rate means higher monthly payments, more interest over the life of the loan, and may also result in higher origination fees that are usually deducted from the loan funds. Although it reduces the amount available to you, you’ll still be charged interest on the entire amount.
The amount you can borrow may be reduced
Lenders may limit the amount they lend to borrowers with poor credit because borrowers who have a history of credit problems are more likely to default on their loans. Lenders often place a cap on the amount they will lend to reduce the amount of losses they can make.
Tenure is likely to be short
If you have a bad credit history, you may not be able to take advantage of the lender’s maximum term. Lenders with bad credit history may prefer that you pay off the loan faster to reduce the chances of defaulting over a long period of time. Use a personal loan calculator to ensure that your payments stay within your budget.
How do you avoid bad credit loans?
People with bad credit are easy targets for financial criminals. Not all loans for people with bad credit are legitimate, so take extra care to avoid becoming a victim of unscrupulous lending.
- Has the lender contacted you unsolicited? It is always you who initiates contact with lenders, not the other way around, so if you suddenly get a call about a loan with bad credit, you may be being scammed.
- Does the lender require an upfront fee? Legitimate personal loan lenders will never collect fees up front. All fees should be collected at the time the loan is funded.
- Is the lender reputable? The lender should be registered to do business in your state, have a physical address and a secure website, and check the Consumer Financial Protection Bureau’s (CFPB) complaint database for actions against the lender.
- Is the lender touting “guaranteed approval”? A lender cannot guarantee loan approval without verifying some of your financial information, and if they do, the lender is probably not legitimate.
- Will lenders charge a prepayment penalty? Check the terms of any bad credit loans that have prepayment penalties. This isn’t a red flag for a scam, but you don’t want to be locked into a loan that will force you to pay high fees to refinance if your credit improves in the future.
- Do you feel pressured into accepting a loan? Never take out a loan with bad credit, even if a salesman pressures you. A reputable company should tell you the benefits of the loan and show you how it can improve your financial situation. Pushy sales tactics are a red flag that you’re dealing with a predatory lender.
Bad credit loans are a quick source of liquidity of last resort. Unfortunately, this market is filled with unscrupulous lenders looking to rip off consumers. Stay away from lenders that aren’t registered with your state or that have been criticized or penalized by the CFPB for regulatory violations.
— Thomas Block, CFA, CPA
Conclusion
Bad credit personal loans come with high APRs and fees, so look at cheaper alternatives first. If you’re having trouble getting approved for other types of loans and you need cash, it might be worth considering a bad credit personal loan. However, this should be part of a larger strategy to improve your credit and finances in the long term.
If you’re unsure about loan programs, talk to a credit counselor before deciding. If you decide this is the best financing option for you, compare personal loan interest rates, terms, and fees to find the best plan for you.
