People with credit problems often feel shut out of the financial system. However, with an expanded range of lending options, there may be more personal loans for bad credit borrowers.
If used carefully, personal loans can help rebuild your credit, as long as you don't repeat the same mistakes that damaged your credit in the first place.
Personal loans for bad credit: defined
For starters, what do people mean when they talk about "bad credit?"
If you have a credit score of 670 or better, lenders are likely to view you as a reasonably safe risk. On the other hand, if you have a score below 580, your credit score is in the bottom 17 percent of the population. At that level, you are unlikely to find a legitimate lender who extends a loan to you.
The grey area between good credit and terrible credit is the range between 580 and 670. That level means you probably have some credit problems, but it isn't hopeless. Your credit is bad enough that it is likely to cost you more to borrow, but you still have a chance of getting a loan.
Of course, just because you can get a loan doesn't mean you should. Before you borrow, you should weigh the pros and cons of taking out a personal loan with bad credit.
Bad credit? Personal loan pros and cons
Disadvantages of additional borrowing when you have bad credit relate to high costs. In theory, personal loans can be a cheaper alternative to credit card debt. Personal loan rates on average are lower than credit card rates, but those averages go out the window when it comes to people with damaged credit. A look at lending sites that cater to lower-credit score borrowers found some personal loan rates in excess of 35 percent, compared to the national average of 10.31 percent.
At the higher end of the rate scale, you should think long and hard about whether it's cost-effective to take out a personal loan. Another potential drawback is that borrowing money with bad credit can do further damage to your credit score. The additional debt will probably count against you, and things can get even worse if you are late in repaying the loan.
There can be an upside to getting a personal loan when you are committed to repairing your credit. The best case, if you plan carefully for how to repay the loan, is that a successful borrowing and repayment experience might help you rebuild your credit history. You can improve your chances of a positive outcome if you shop carefully for your personal loan.
How to get a personal loan with bad credit
Here are eight tips for how to get a personal loan when you have bad credit:
- Fix your credit report
There may be mistakes you can clear up or late payments you can catch up with. Also, if there are some older problems on the report, you might want to wait for them to drop off before you apply for your loan.
- Look beyond banks
Big, traditional banks tend to be the most conservative. Local banks and credit unions may have programs more geared to the needs of your area, and peer-to-peer lending sites can match you up with investors who are willing to take some risk.
- Prepare a budget
For your benefit and the lender's, prepare a budget for how you will repay the money given your current income and financial obligations.
- Consider collateral
If you have anything of value that can be put up as security for the loan, this might go a long way toward reassuring a potential lender.
- Find a co-signer
Getting someone with good credit to co-sign the loan with you is another way to reassure lenders -- if you can find someone willing to put their credit record on the line for your loan.
- Compare rates for your credit score
Rate shopping may be especially important for poor-credit borrowers, since rate differences may be greater at higher rate tiers.
- Keep loan terms short
Given how high personal loan rates are for borrowers with poor credit, choosing a three-year rather than a five-year loan can make a substantial difference in how much total interest you pay over the life of the loan.
- Know where to draw the line
Taking on an interest rate of 30 percent or so is a questionable enough financial decision, but make sure you do not resort to using a short-term payday lender. According to the Center for Responsible lending, annual percentage rates on these paycheck-to-paycheck loans average a staggering 391 percent.
Getting a personal loan with bad credit isn't easy, and that's just as well. Forcing you to think carefully about the loan before you commit could keep you from making an expensive mistake.