When you have bad credit, taking out a loan means spending some extra cash on interest. But does it have to be that way?
High interest rates are one of many things that plague the lives of people with bad credit. But are these high fees really an unchangeable fact of life? Next time you need to take out a bad credit loan, is there a way to get around the crazy-high interest rates that payday and title lenders charge?
How do interest rates work anyway?
Let’s start with the basics. Lenders charge interest, or a set percentage of the total loan amount, in order to make sure you pay back your loan on time, and to pad their own pockets with a little profit on the loan.
For example, if you take out a $1,000 dollar loan with a 5% annual interest rate, you’ll have to pay $50 in interest if you pay back the loan in one year, $100 if you pay off the loan in two years—etc.
Lending is a big business in the U.S., and this is ALL because of interest. Interest is how lenders make money which is (don’t forget) what lenders want to do.
Why does your credit score matter?
Many lenders (*cough* bad lenders) look at the world like a giant casino where their borrowers are the slot machines. Unlike regular slot machines which barely ever give their players a payout, whenever a borrower pays back their loan in full with interest, the lender gets a jackpot.
Sure, it’s not much, maybe just a few cents per dollar put in, but when you multiply that out over hundreds or thousands of loans, it adds up.
There are slot machines in this casino that lenders will play every day, without hesitation, and these are people with prime credit ratings. There’s little risk and lots of reward in lending to people with a history of paying their debts.
But at the other side of this hypothetical casino there are slot machines that only pay out half the time. These slot machines are people with bad credit or a history of late or delinquent payments, and most lenders avoid playing them at all, because they don’t want to risk losing the money they lend.
So how does this casino get lenders to start playing again? Hike up the payout amount. Unlike the reliable slot machines across the room, which pay out a few cents for every dollar you put in, these babies will pay out 50 cents to the dollar—but only half the time.
NOW it’s worth the risk to the gambler, because even though they won’t always win, when they do, it’s enough to make up for their losses, and then some.
A borrower’s credit rating is essentially a prediction, based on past behavior, of how likely that borrower is to pay back their loan plus interest. Lenders assume that potential borrowers with lower credit ratings are less likely to pay back their debts, so they’ll only lend to people with subprime credit if the payout is big enough to make up for all the other subprime borrowers who won’t pay back.
Like the casino owners who up the payout amount, lenders ensure they make a profit on people with bad credit by raising their interest rates.
How can you find a GOOD lender?
Here’s the thing: Good lenders don’t see their customers as slot machines. Good lenders are willing to gamble a bit in order to get you the best rate possible. If this means collecting a little less in interest when you pay your loan back, so be it!
A good lender knows that a credit rating isn’t the only way to judge whether someone can pay back a loan or not. So how can you find a good lender?
Nationally recognized credit expert Jeanne Kelly advises potential borrowers to do do some digging before taking the plunge.
“Make sure you do your research on the company and the account you are applying for,” she says.
You might also want to avoid lenders who perform hard credit checks, which can hurt your credit. Instead, you’d be better off seeking a lender who performs a soft credit check, which will not appear on your credit report.
Look for lenders who can give you rates that are significantly lower than what you’d find at a payday or title loan storefront, who give reasonable payment terms, and are transparent about how much you’ll be paying in interest from the get-go.
A surefire way to see which lenders to avoid? Check for a lot of bad online reviews. If customers are, as a whole, unhappy with the way they were treated, or feel like they were scammed, you should run far, far away and never look back.
But good online reviews are a (wait for it) good sign! Look at sites like Yelp and Google, and check out the Better Business Bureau as well.
A high accreditation on the BBB will help identify legitimate businesses, while bad reviews (or no accreditation) can signal dangerous lenders. James Sinclair, a manager at Trade Financial Global warns potential borrowers that they need to do their research or pay the price.
“In relation to spotting a dangerous lender, look at the clauses they add to an agreement,” Sinclair suggested. “Especially in relation to a missed payment—what will the effect be? What is the penalty? Understand the downside risk. It is important to understand the documents you are signing.”
The bottom line: you have options.
No matter how bad your credit, nor how dire your need for fast cash, you should try to avoid predatory payday loans. There are other options out there for you, as well as ways you can improve your credit over time.
“If you are tired of having no credit or a low credit score, start to rebuild with a secured credit card that will report to Experian, Equifax & Trans Union,” said Kelly. “You can start to build a good history on the new account and keep balances low.”
Of course, things happen. If an emergency expense pops up before you can fix your credit, do yourself a favor and do your research before you borrow.
Jeanne Kelly (@creditscoop) is an author, speaker, and coach who educates people to help them achieve a higher credit score and understand credit reporting. #HealthyCredit is her motto. As the founder of The Kelly Group in 2000 and the author of The 90-Day Credit Challenge, Jeanne Kelly is a nationally recognized authority on credit consulting and credit score improvement.
James Sinclair, is a manager with Trade Finance Global. Trade Finance Global (TFG) is an international company focused on structured debt. They use their relationships with banks and alternative finance houses to structure and negotiate trade lines for their clients. There are more details online at TradeFinanceGlobal.com (@tradefinglobal).
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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.