elenaleonova/GettyImages; Illustration by Hunter Newton/Bankrate
Key takeaways
- Bad credit loans typically have higher interest rates and fees, so it’s important to calculate the total borrowing cost before accepting an offer.
- Many lenders consider factors beyond your credit score, including your income, employment history and debt-to-income ratio.
- Legitimate lenders won’t guarantee approval or ask for upfront payment before funding your loan.
Personal loans for bad credit are designed for borrowers with credit scores of 580 or lower. While these loans make financing accessible if you don’t qualify with a traditional bank, they often come with higher costs and stricter terms. When you’re ready to borrow, be sure you understand how subprime lenders evaluate borrowers with bad credit and how those decisions affect the total amount you’ll repay.
What are bad credit loans?
Bad credit loans are a type of personal loan, but because lenders take on more risk, they often have higher interest rates and fees. This leads to a higher annual percentage rate (APR) than loans for borrowers with stronger credit. Still, they generally work the same way: You receive a lump sum upfront payment and repay the principal, plus interest, in fixed monthly installments over a repayment term that typically ranges from one to seven years.
A longer repayment term can help spread out the cost and result in lower monthly payments, but it’s more expensive in the long run. Since interest has more time to accrue over a long term, you’ll pay more for the loan in the end. Generally, you should select the shortest repayment term you can realistically afford.
How much do bad credit loans cost?
When borrowing with a credit score under 600, it’s important to balance your immediate monthly cash flow against the long-term cost of a loan. Depending on the type of loan, you may see an APR — which includes both interest and fees — above 20%. And with some bad credit lenders, you may see rates well over 300%.
The following table illustrates how different terms and APRs impact a $5,000 loan:
| Loan 1 | Loan 2 | Loan 3 | |
|---|---|---|---|
| APR | 30% | 28% | 35.99% |
| Repayment term | 2 years | 3 years | 4 years |
| Monthly payment | $280 | $207 | $198 |
| Total cost of interest | $1,710 | $2,445 | $4,497 |
- For minimum interest cost: Loan 1 is the most cost-effective. While the monthly payment is the highest, you pay significantly less over the life of the loan. In this scenario, you avoid paying nearly $3,000 in extra interest compared to Option 3.
- For monthly cash flow: Option 3 offers the lowest monthly payment. However, the nearly 36% APR, combined with a 4-year term, means you will pay nearly as much in interest as you initially borrowed, effectively doubling the total cost.
Crunch the numbers to choose the right loan
Before committing to a personal loan for bad credit, use a personal loan calculator to check your offers. Focus on the total cost of borrowing, rather than just the monthly payment, to ensure the loan doesn’t create a secondary financial emergency.
Pros and cons of bad credit loans
Bad credit loans may be your only option if you need cash for an emergency expense, home improvement or big purchase and have been turned down by traditional lenders. It’s important to consider the advantages and disadvantages of this type of loan before moving forward.
Pros
- More flexible approval guidelines: Bad credit lenders have lower credit score requirements and may consider alternative criteria when making a lending decision, including income and education.
- Could help improve your credit score: If you make on-time payments, you could boost your score over time.
- Less risky than credit cards or payday loans: Credit cards and payday loans can get you into a cycle of debt since they allow for minimum payments (credit cards) or have to be repaid every two weeks (payday loans). Plus, payday loan rates can be as high as 400 percent APR.
Cons
- High fees and interest rates: APRs can be as high as 35.99 percent, while rates for borrowers with excellent credit could be as low as 6 percent. You may pay origination fees of up to 12 percent of your loan amount, and these fees reduce the amount you receive when your loan funds.
- Collateral requirements: Some bad credit loans require collateral to approve you for the funds. Secured loans offer more affordable rates than traditional unsecured personal loans since the risk to the lender is reduced. But if you default on your loan, the lender could seize your asset and sell it to repay your debt.
- Increased predatory potential: It’s common for predatory products like payday loans to be advertised as bad credit loans. The primary difference between a legitimate and a predatory product is the interest rate — up to 36 percent versus 400 percent or more, respectively.
How to apply for a bad credit loan
Although every lender has a slightly different application process, most have similar requirements and required documentation. Follow these steps to improve your approval chances and keep your borrowing costs as low as possible.
- Work on your credit score: Even small improvements such as fixing errors, lowering your utilization and avoiding applying for new credit can help you qualify for a better rate.
- Review your budget: Since bad credit APRs can climb as high as 35.99%, only borrow what you need and use a personal loan calculator to estimate a payment you can comfortably afford.
- Prequalify with multiple lenders: Submit applications with at least three lenders to see what your potential loan terms will be. Prequalification involves a soft credit check, so you can review estimated rates without hurting your credit score.
- Complete your application carefully: Prepare documents that prove your income and other finances before you start, then double-check your application for errors. Simple mistakes can lead to automatic denials.
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Signs of a predatory lender
Not all bad credit loans are legitimate or affordable, so take extra precautions to avoid being a victim of predatory lending.
- Does the lender want upfront money? No legitimate bad credit lender should charge an upfront fee. It’s standard practice for the fees to be deducted from your loan funds before the remainder of the money is deposited into your account.
- Did the lender reach out to you unsolicited? You should always be the one to initiate contact with a lender. If you suddenly start getting calls about bad credit loans, you may be dealing with a scam.
- Is the lender reputable? The lender should be registered to do business in your state and have a physical address and a secure website. Check the Consumer Financial Protection Bureau’s (CFPB) complaint database for any actions against the lender.
- Does the lender market “guaranteed approvals?” No lender can guarantee a loan approval without reviewing some of your financial information. If they do, they are probably not legit.
- Do you feel pressured to accept the loan? Never, ever take a bad credit loan out because a salesperson pressures you to do so. Any reputable company should share the benefits of the loan and show you how it can improve your financial situation. Strong-arm sales tactics are a red flag that you’re dealing with a predatory lender.
Unfortunately, this market is filled with unscrupulous players looking to take advantage of consumers. Stay clear of any lender that is not registered with your state … or has been censured or penalized by the CFPB for regulatory violations.
— Thomas Brock, CFA, CPA
Bottom line
Although bad credit personal loans come with high APRs and fees, they can be a worthwhile financial cleanup tool. The fixed monthly payment is a good alternative to variable credit card payments.
If you use one to consolidate multiple debts, you could avoid an accidental missed payment since you’ll only have one new personal loan payment. Explore cheaper alternatives for bad credit if the payments are too steep for your budget.
If you’re not sure about the loan program, talk to a credit counselor before making a decision. If you determine that it’s the best financing option for you, compare personal loan rates, terms and fees to find the best deal.
Frequently asked questions
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A guaranteed approval personal loan is a tell-tale sign of a scam. Reputable lenders review your financial information when you apply for funding. So, if a lender guarantees you’ll receive approval, you should look elsewhere to borrow the cash you need.
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Do your research to find lenders that cater to credit-challenged borrowers. Get prequalified with at least three to gauge your eligibility for funding. Have your income documents ready, and consider a co-signer if the lender allows them.
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If you can’t get approved for a bad credit loan or prefer to look elsewhere, there are still ways to get the cash you need. Bad credit loan alternatives to consider include early payday apps and buy now, pay later loans. You can also use a credit card if one is available, or consider a cash-out refinance if you have a sizable amount of home equity.
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