What to consider before applying for a bad credit loan
Key takeaways
Interest rates can frequently top 30 percent and may result in paying much more for the loan than you would if you had good credit.
High fees are also common with bad credit loans, which will increase your cost of borrowing.
The amount you can borrow is limited — typically $1,000 or less, depending on the lender.
Alternatives may offer less expensive ways to borrow, so look into other options before taking out a bad credit loan.
A bad credit loan can be a convenient and simple way to cover a large expense or unexpected bill. However, lenders charge significantly more when your credit score is lower. Before you apply, determine how much it will cost you — and look into alternatives that might be more affordable.
Top considerations before applying for a bad credit loan
Bad credit loans offer convenience for borrowers who may not be able to qualify for other options. However, there are a number of risks when you borrow a bad credit loan.
They will be more expensive because lenders will charge higher interest rates or — depending on the type of loan — more fees. You may also be limited in how much you can borrow and how long you have to repay your loan.
So while a bad credit loan has some benefits, it is worth looking into alternatives or waiting until your credit improves before you apply.
See related:5 risks of a bad credit loan
1. Bad credit loans cost more
Because borrowers with bad credit are viewed as more risky, they face higher interest rates. For many people, this looks like rates above 30 percent. Combined with a higher origination fee — the cost to process a loan — and you will wind up with a much more expensive loan. This means higher monthly payments and more interest paid overall.
2. You may not be able to borrow as much
You may also be limited to how much you can borrow. While the amount you are eligible for is typically based on your income and other debts, a lender may not be willing to give you as much if you have bad credit. If you need a larger amount, it may be difficult to qualify for.
3. Your term will likely be shorter
Similarly, your loan term is also based on your credit. You may not be eligible for longer terms of five or more years because it increases the risk of default.
Unfortunately, that means you may face a higher monthly payment when you borrow a bad credit loan. And while shorter terms can cut down on the amount of interest you pay, a high monthly payment could make it difficult to cover your everyday expenses.
How a bad credit loan compares
The primary difference between personal loan costs is the interest rate set by your lender. Borrowers with good credit have access to lower rates, which makes their loans less expensive.
This is why you should try to improve your credit before you borrow if you can. It may end up saving you hundreds of dollars — and lower your monthly payments.
For example, a loan of $5,000 with a three year term could cost over $1,500 more if you have bad credit. This is because the average personal loan rate for a borrower with bad credit is 28.50 percent to 32 percent. For a borrower with good credit, rates are significantly lower, ranging from 13.50 percent to 15.50 percent.
Interest rate | Monthly payment | Total cost |
|---|---|---|
13.50% | $170 | $1,108.35 |
15.50% | $175 | $1,283.92 |
28.50% | $208 | 2,494.15 |
32% | $218 | $2,839.79 |
See related:Statistics and how to build your credit
How to find the best bad credit loan
To find a bad credit loan, you will need to know your financial situation and spend time comparing at least three lenders. Bad credit loans are primarily available from online lenders, although there are some credit unions that offer alternatives with a low interest rate cap.
Know your credit score. Even bad credit lenders will set a minimum credit score, usually 500 or 600 points. This can make a big difference when it comes to the loans you qualify for, so check your score before you look for lenders.
Compare loan options. There are types of bad credit loans, like payday loans and car title loans, that are significantly more expensive and risky than standard personal loans. Be aware of these when you are considering a loan.
Prequalify with three or more lenders. Many lenders allow you to prequalify to check your rates without impacting your credit score. You can use this process to compare lenders and see which offers the best terms.
Determine the cost. Use a personal loan calculator in addition to prequalifying for a loan to determine the cost. Check monthly payment against the total amount of interest you will pay. And while interest rates are a big consideration, look at fees and the full cost as well.
Add a co-signer. If possible, apply with a co-signer or another borrower who has a higher credit score. This can help improve your chances of approval. The other person will also be taking on risk, so be sure you both know what you’re getting into before borrowing together.
Alternatives to bad credit loans
Bad credit loans are far from your only option. There are several alternatives if you have bad credit. You may face similar rates if you opt for a credit card or home equity loan, but the risks are different from a bad credit loan. And while help from friends and family may not come with high rates, it has its own drawbacks you should be aware of.
In addition to these, consider credit counseling. It can help you manage your finances, negotiate with lenders and improve your situation for future loans.
Credit cards. For frequent small expenses, you may want to compare credit cards for bad credit. These give you much more flexibility than a loan, can help you build your credit and may give you access to perks like cashback bonuses.
Home equity loans. A home equity loan or home equity line of credit (HELOC) is secured by the equity in your home, which means lower rates for borrowers with bad credit. They may be more accessible if you have a large expense you need to cover, but you risk your property if you default.
Friends and family. Your friends and family may be able and willing to help you out when you’re facing a financial setback. Be clear about your ability to repay, pay interest and put everything in writing. This can be a danger to your relationship, so be upfront with your loved one.
Credit counseling. The process of credit counseling can help you get out of debt. While it won’t be able to provide a loan, it can help you rebuild your finances for future borrowing. Combined with a bad credit loan or alternative, credit counseling may be a helpful tool.
