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Bad Credit Personal Loans

A personal loan is an unsecured type of loan granted an individual based on their creditworthiness alone. Unsecured means there is no specific asset used as collateral to protect the lender should the borrower default on the loan. There are different types of personal loans. Many are installment type loans, where the borrower repays the loan with an establish repayment schedule. Alternately, the loan can be a line of credit, also called a revolving loan, where the balance can fluctuate based on the borrower’s use of the available balance, similar to a credit card.

Since the creditworthiness of the borrower is the basis of the loan decision, personal loans typically have a higher interest rate than other types of loans. Personal loans are a higher risk product for lenders. For example, with an automobile loan, the loan is financing the car, so the car is the collateral. If the borrower defaults on the loan, the lender can repossess the car, and then sell the car to satisfy the outstanding balance of the loan. The same is true of a home loan. If the borrower defaults on the loan, the lender can foreclose on the property and take possession of the home. In both cases, the asset that the loan was being used to purchase would secure the lender.

Although personal loans are unsecured, lenders ask applicants to list on their applications valuable property they own. They do this to determine if the borrowers have assets they might be able to obtain if borrower defaults on the loan. Regardless, the loan rates are higher because there is greater risk for the lender.

For individuals with bad credit, the rates for personal loans are even higher than they are for borrowers with good credit. As with all loans, lenders set interest rates based on multiple factors, the primary determinant with personal loans being the individual’s credit score. Therefore, consumers with bad credit must do their research before entering into a personal loan agreement to make certain this is the right product for them. It is also advisable to exhaust all possibilities before considering a personal loan due to the high cost and difficult repayment options.

Reasons for Personal Loans

There are many reasons why consumers may seek a personal loan. They may choose to consolidate other debts into one loan; use the money to make improvements to their home; take care of emergency car repairs; pay a tax bill; or even pay medical expenses. The specific purpose for the loan may vary person to person, but the bottom line is the same: the borrower needs money and may believe they have no other alternative.

Who Uses Personal Loans

Personal loans are not solely for people with bad credit. Many consumers use personal loans. More likely the reason people need personal loans is they have difficulty managing their personal finances. Personal loans are definitely, for times when funds are low and people have exhausted other alternatives, or do not know where else to turn. Additionally, they may not realize that personal loans have extremely high interest rates compared to other products and that other options might be better choices.

Terms of a Personal Loan

The amounts and terms of personal loans vary based on the dollar value of the loan. The typical personal loan term is 5 years and the loan amount can range from $5,000 to $50,000, depending on the purpose of the loan and the borrower’s ability to repay. Other personal loans offer quick cash without a credit check and have exorbitant interest rates, such as payday loans. Borrowers can secure loans from $100 to $1,000, but the repayment terms are much shorter.

Cost of Personal Loans

Personal loans have a high interest rate, making them an expensive, almost prohibitive product. When compared to other loan types, personal loans are one of the more expensive loans a consumer can purchase. Furthermore, consumers with bad credit will pay even more for personal loans, as they do with other loan types. Lenders base the interest rates they charge borrowers for personal loans on the applicants’ credit scores. The higher the credit score of the borrower, the lower the interest rate charged. Conversely, the lower the credit score, the higher the interest rate, as the following example illustrates.

5-Year Repayment Term, $10,000 Personal Loan:

Credit Score Rate* Payment Variance Interest Paid Variance
Excellent 6.50% $196 - $1,740 -
Very Good 8.50% $205 $10 $2,310 $570
Good 10.50% $215 $19 $2,896 $1,157
Fair 15.50% $241 $45 $4,432 $2,692
Poor 25.50% $296 $101 $7,787 $6,047
Very Bad 35.50% $358 $162 $11,487 $9,747

*Hypothetical breakout by credit ranking, based on actual advertised lowest and highest interest rates

In the above example, for a 5-year term personal loan, a consumer with excellent credit could obtain a loan with a 6.5 percent interest rate. The monthly payment would be $196 and the total interest paid for the $10,000 borrowed would be $1,740. The lowest interest rate for a borrower with an excellent credit rating for a personal loan is 6.5 percent. For a home loan, the current average rate is between 3.5 and 4.0 percent for borrowers with an excellent credit rating.

The consumer with very bad credit may gain approval for a loan with an interest rate of 35.50 percent. The monthly payment for a $10,000 loan at 35.50 percent would be $358, making the total interest paid over the life of the loan $11,487. The borrower with very bad credit would pay $162 more each month for the same loan, and would pay a total of $11,487 in interest to the lender, which is $9,747 more than they would pay if they had excellent credit. As this example illustrates, personal loans are very expensive and for consumers with bad credit, they may not be the best option. To learn more about credit scores and interest rates, visit the FICO credit score website at http://www.myfico.com/HelpCenter/FICOScores/

Who Offers Personal Loans

Many financial institutions, such as banks, credit unions, and online lenders, offer personal loans. The government also has resources available for consumers in need. Consumers should research and compare rates and terms to ensure they get the best deal to meet their needs. Additionally, it is a good idea to exhaust every option before turning to a personal loan. Family and friends might be willing and able to loan money by accepting a promissory note, which may provide more flexible repayment terms for the borrower. Often, churches have funds available for members who need a helping hand.

Consumers need to be cautious when seeking personal loans. There are many unscrupulous lenders and “scam” artists perpetrating frauds that offer “too good to be true” deals that are just that, too good to be true. Consumers would be wise to avoid credit offers received in the mail for “free cash, no credit check” or “give us $100 and we’ll give you $1,000”. It is easy to fall victim to predatory lending schemes when people are in a financial crisis.

There are laws and regulations in place to protect consumers from predatory lending practices. Consumers should know their rights and make informed decisions before entering into any loan agreement. It is also important for consumers to know where they can get help if they have encountered fraudulent lending practices. To learn more, visit the Federal Trade Commission website at http://www.ftc.gov/bcp/edu/microsites/moneymatters/scam-watch.shtml

Alternatives to Personal Loans

Consumers with bad credit should consider alternatives before entering into a personal loan agreement. The interest rate is high, meaning a high monthly payment and interest. That money could be better spent repaying other outstanding debt. If a personal loan is a consumer’s only option, they may decide to start taking a hard look at their finances and find ways to cut back. It is never too late to start repairing credit and learning to save money for emergencies. It is difficult to pay down debt, especially if new debt is continuously being acquired, particularly expensive credit like personal loans.

There may be ways to cut costs, like downsizing a home, considering an equity loan to consolidate debt at a lower rate than credit cards and personal loans. Equity loans have an advantage because the interest is tax deductible, credit card and personal loan interest is not.

If a borrower gets into debt too deep and cannot pay their bills, the lenders can sue them. Although personal loans are not secured with collateral, that does not bar the lender from taking legal action and attaching the borrower’s valuable possessions. If the borrower purchased an asset with the loan proceeds, the lender may attempt to recover their balance by securing that property. Borrowing money to pay other debts will only perpetuate the same vicious cycle of debt. Consumers would benefit from seeking alternatives to personal loans to sort out their financial troubles and get on a path to mending their financial difficulties. It is never too late to start working toward repairing personal finances and building good credit.

 


 

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