Once you answer these questions, that short-term loan payday loan you've been eyeing might not look like such a great idea anymore.
Borrowing money when you have a lousy credit score isn’t easy. There are tons of lenders out there offering easy approval loans, but it can be really hard to figure out which of them are worth it. And choosing the wrong bad credit loan could end up wrecking your finances for a long time to come.
That’s why we want to make the process a bit easier for you. Here are five important questions that you should ask before taking out a bad credit loan. The answers to these questions should go a long way towards guiding your decision—and helping you make the right one.
1. What’s the annual interest rate?
Okay, so this is a question you should be asking about any personal loan, not just a bad credit loan. But it’s also true that loans for bad credit—even the good ones—are going to come with much higher interest rates than standard personal loans. Choosing the wrong bad credit loan could end up costing you hundreds or even thousands of dollars in additional interest.
When you look at the interest rate for short-term bad credit loans like payday loans, you’ll often see an interest rate in the range of $15 per $100 borrowed. That seems a bit high, sure, but you know that this is the cost of borrowing money with poor credit. (These rates will also vary depending on what state you live in.)
But with those sorts of loans, the simple interest rate doesn’t tell the whole story. You also need to look at the annual percentage rate, or APR. This is a standardized metric that measures how much a loan would cost over the course of a full year, letting you make cost comparisons across all different kinds of loans.
Let’s return to that $15 per $100 borrowed rate: For a two-week payday loan, that cost works out to an APR of 391%. That’s a lot! And while it might not seem like annual rates would matter when it comes to short-term payday loans, they definitely do. We’ll explain more in later sections.
In fact, when it comes to short-term loans, those sorts of sky-high interest rates are pretty common. Title loans, which are secured by the title to your car or truck, come with average APRs of 300%.
Checking out a bad credit installment loan could be a good way to sniff out lower annual rates, but your best bet may come with joining a local credit union, many of which offer Payday Alternative Loans (PALs) that come with a max interest rate of 28%. You could look into joining a credit union now if you think you may need a PAL later.
2. Is the loan amortizing?
While the overall interest rate on your bad credit loan is going to be important, you’ll also want to make sure that the loan is amortizing. This could be the thing that saves you from getting trapped in a predatory cycle of debt.
Amortizing loans don’t charge interest as a single flat fee; they accumulate interest over time, which means that a) your loan will accrue less money in interest as you pay down the principal, and b) that paying your loan off early will save you money overall.
(That second benefit assumes that your loan doesn’t charge prepayment penalties. So make sure you find that out as well before borrowing.)
But here’s the most important thing about amortization: It ensures that every payment you make goes towards both the principal and the interest. So each time you make a payment towards your loan, you get one step closer towards being out of debt.
That seems … pretty obvious, right? Well, unfortunately, it’s not always the case. Short-term bad credit loans often charge interest as a flat fee, and they come with the option of rolling over your loan in order to extend your due date. Rolling over a loan often consists of paying only the interest owed in exchange for receiving a new loan term, complete with additional interest.
For people who struggle to afford their loans, loan rollover can leave them trapped in a dangerous cycle. Every couple weeks or every month they make payments towards the interest owed without ever paying off any of principal loan amount. No matter how many payments they make, they never get any closer towards actually getting out of debt.
This is why amortization is so important. If you’re taking out a bad credit loan, choose a loan that has an amortizing payment structure—otherwise, you could find yourself in a cycle of high-interest debt.
3. Can I afford the payments?
Earlier in this piece, we mentioned that the annual rate for short-term loans can be far more relevant than you might think, which mostly comes down to people not being able to afford their payments. The more that people have to roll over their loan or reborrow another loan in order to make ends meet, the more they end up paying in interest.
This is especially relevant when it comes to short-term bad credit loans like payday and title loans. Think about it: If you borrowed $400 at a 15% interest rate and then had two weeks to pay back $460, would you be able to swing it? Many can’t, at least not without having to take out another loan in order to pay the rest of their bills and living expenses.
In fact, a study from the Pew Charitable Trusts found that only 14% of payday loan borrowers had enough money in their budget to make their payments. And data from the Consumer Financial Protection Bureau (CFPB) has stated that the average payday loan borrower takes out 10 loans per year, spending an average of 200 days in debt.
The higher interest rates for bad credit loans are always going to mean some belt-tightening in order to make your payments. But there’s a big, big difference between tightening your belt and having to cinch it so small that you practically cut yourself in half.
Bad credit installment loans often mean paying more money towards interest overall when compared to payday and title loans, at least on paper. But that longer loan repayment term also means smaller individual payments. Having payments that fit within your budget and let you get out of debt on-schedule can definitely be worth the extra money.
4. Do they check my ability to repay?
Bad credit loans are also sometimes referred to as “no credit check loans” because the lenders in question may not do a hard credit check when processing a customer’s application. This makes sense since people applying for these loans already have poor credit scores.
But there’s a big difference between not running a hard credit check and not checking whether a customer can afford their loan altogether. One of them speaks to the realities of bad credit borrowing, but the other can be a sign of something far more sinister.
Lenders that don’t do any work to verify a customer’s ability to repay their loan could very well be actively hoping that their customers don’t repay on time. That way, they roll over or reborrow their loan, which means increased profits for the lender.
On the flip side, lenders who want to check a customer’s ability to repay can run what’s called a “soft” credit check, either from one of the three major credit bureaus (Experian, TransUnion, Equifax) or from an alternative consumer reporting agency.
These checks return less information than a hard credit check, but they also won’t affect your credit score. There are also other methods beyond a soft credit check—like verifying your income—that lenders can use to determine your ability to repay a loan.
Nobody who has bad credit wants a hard credit check when they’re applying for a loan. All it’s going to do is ding their credit; that’s the last thing they need! But they should still choose a lender who cares about their ability repay. That’s a sign that this loan will help forge a path to a bright financial future instead of digging their finances into an even deeper hole.
5. How do other customers feel?
When you’re looking for a place to eat or a new place get your hair cut, do you check the customer reviews? Well, why wouldn’t you do the same thing when deciding to borrow money? The experiences of other customers can tell you loads about what a place is really like.
So check out a lender’s customer reviews on Google, and Facebook before applying for a loan. You should check with lending platforms like LendingTree or CreditKarma, as they often have reams of customer feedback and reviews.
And go beyond that! Search out the company’s BBB page to see if they’ve had complaints registered against them and how those complaints have been resolved. Even a thorough Google search for the company might turn up information that will sway your decision.
There are any host of factors to consider when applying for a bad credit loan, and there are many questions you should be asking beyond the five we’ve listed here. But possibly the most important question is: What’s the best loan for you? Once you have that figured out, your decision should be an easy one.
In the long-term, the best way to avoid predatory bad credit lenders is to … fix your credit score!
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The information contained herein is provided for free and is to be used for educational and informational purposes only. We are not a credit repair organization as defined under federal or state law and we do not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit. Articles provided in connection with this blog are general in nature, provided for informational purposes only and are not a substitute for individualized professional advice. We make no representation that we will improve or attempt to improve your credit record, history, or rating through the use of the resources provided through the OppLoans blog.