How to Stay Safe With a Bad Credit Loan
Have you seen all those stories recently about turkeys flying into people’s windshields? Yeah, we know, they’re really weird. But they also raise the question: what would you do if something like that happened to you? Would you be able to afford the car repairs (or your subsequent psychologist’s bills)?
If you’re one of the 6 out of 10 Americans who have less than $500 in savings, then the answer is: probably not. In that case, the odds are good that you’ll have to take out a loan to pay for the repairs. And if your credit isn’t so hot, you’ll likely be turning to a loan from a bad credit lender.
While your interest rates with a bad credit loan are almost always going to be higher than they would with good credit, these loans can still make a ton of financial sense if you’re in a pinch. The key is making sure you stay safe and avoid the predatory bad credit lenders that want to trap you in an unending cycle of debt.
Taking out a bad credit loan from the wrong lender could leave you feeling like a real turkey.
1. Research your options ahead of time.
Your chances of avoiding a predatory bad credit lender are better if you do your research before applying for a loan. And they’re much better if you do your research before you’re in a bind and pressed for time.
While researching potential lenders, check out their ratings and reviews from the Better Business Bureau to see if they’ve been accused of shady dealings in the past. You can also check with your local consumer protection agency to see if any complaints have been filed against them.
And don’t forget user review sites either! Head on over to Google, Facebook, and LendingTree. If customers have had a bad experience or been subjected to misleading terms when signing up for a loan with this lender, they’ll let you know!
The Home Economist blogger and author Brett Graff (@BrettGraff) warns that you should “Be wary of a lender that’s not interested in your credit history, one that offers loans over the phone, or a lender using a name that sounds like a reputable bank. Many scammers do that to sound reputable but aren’t. Don’t deal with a lender who asks you to wire money or pay an individual. Stay safe by making sure the company has a physical address and check the phone number against the one online.”
Doing your research ahead of time will allow you to be thorough and methodical. Rather than just rushing through the first page of Google results for “Bad Credit Lender,” you’ll be able to calmly judge which lender is the best one for you.
You’ll want to make sure that you also compare rates between different lenders. Which brings us to #2 on our list …
2. Do the math!
A lot of bad credit lenders fall under the category of “payday loans.” This means that they offer short loans, ones that are usually meant to be paid back in only two weeks. The interest rates for these loans can seem pretty reasonable. Oftentimes it’s something along the lines of “$15 to $20 per $100 borrowed.”
But dig a little deeper and you’ll find that many of these loans are dangerously expensive compared to your other options. You see, these loans may only charge 15 or 20 percent, but that’s 15 or 20 percent over a short two-week span.
Many payday loan customers have trouble paying these loans off when they come due (that’s the downside of short repayment terms) and so they end up “rolling the loan over.” or extending the due date in return for an additional interest charge. Every time they do that, the cost of borrowing increases.
Measure payday loans according to their annual percentage rate, or APR, and you’ll see just how expensive they really are. A two-week payday loan with an interest rate of 15 percent has an APR of 390 percent! Yowzers!
3. Only borrow what you can afford.
If you are unable to make your payment with a payday loan, then you might be given the option of rolling the loan over. If loan rollover is illegal in your state (it’s banned in many places as a predatory practice), or if you’ve reached your rollover limit, you might also be forced to “reborrow” the loan.
Reborrowing means that you pay the loan off using money that you really need to use for other things, like utilities, car payments, or even rent. In order to make those other payments, you then take out a new loan almost immediately after paying the old one off.
Reborrowing and loan rollover are the twin engines that keep the payday debt cycle chugging along. Borrowers are constantly taking out new loans or extending old ones, putting more and more towards interest without ever being able to get ahead.
And, of course, the consequences of not paying back a loan are also pretty nasty. First, you’ll get sent to collections, which means your credit score will take a hit. Even if the lender didn’t check your score when you applied for the loan and doesn’t report your payments to the credit bureaus, the collections agency will inform the bureaus when they take over your account. It’s pretty much a lose-lose.
(Debt collections agencies have a pretty nasty reputation and there are lots of stories out there about debt collectors acting abusively. To learn more about your rights when dealing with a debt collector, check out our blog post: What Debt Collectors Can and Can’t Do.)
If you are still unable to repay your loan, the collection agency will likely take you to court. If the ruling goes in their favor, then they are able to garnish your wages until the debt is fully paid off.
Bottom line: Before you take out a loan, be certain that you can actually afford to make your payments.
Make the lender explain—in as much detail as possible—what your payment schedule will be. And keep in mind that payday loans are designed to be repaid all at once and ask yourself: if you need a $400 loan right now, do you think you’ll really be able to afford a $480 payment ($400 plus 20 percent interest) after only two weeks?
You’ll probably be better off choosing a long-term installment loan. Sure, you won’t get out of debt as fast, but you’ll pay the loan off in series of smaller, regularly scheduled payments. Plus, most of these loans are amortizing, which (long story short) means that you’ll be paying less in interest over time.
A loan is supposed to help you get your finances together. What’s the point of a loan that leaves you worse off than you were before you borrowed it?
Speaking of which …
4. Find a loan that actually helps your credit!
As we mentioned earlier, tons of bad credit lenders out there don’t report your payments to the credit bureaus. While that might not mean a whole lot to you, it’s actually kind of a big deal.
“Your payment history is the most important factor in the consideration of your credit score,” says Kerri Moriarty, one of the founders of Cinch Financial (@CinchFinancial). “The more months you can demonstrate good payment, the faster that bad month (or months) will move off your credit report. It also gives creditors more to evaluate. Let’s say you were using a credit card and missed a payment; creditors can see you missed a single payment in months and months of payments as opposed to seeing that you missed a payment and haven’t used the card since.”
But here’s the thing, if a bad credit lender isn’t reporting your payments to the credit bureaus, then you’re not getting any credit for those payments. Sure, you should be paying them on time anyway, but still, it would be nice to get credit on your credit!
5. Focus on improving your credit score!
Really though, the best way to stay safe with a bad credit loan is to qualify for a loan with better rates!
We already mentioned the importance of making your payments on time. But there are other things you can do to improve your credit as well.
For instance, Moriarty recommends getting a secured credit card: “A secured card requires you to put down a deposit in cash in order to receive the line of credit. It’s basically the creditor’s way of ensuring that there is at least something they will get back in the event that you fail to pay.
She says that “Using a secured card for a few months to a few years lets you demonstrate good credit behavior while the company has no risk. After a while, the card company is likely to offer to upgrade you off of the secured card to the standard, unsecured card—returning your deposit, and graduating you to a rewards card.”
Moriarty also recommends that folks looking to raise their credit score “Make it a point to keep an eye on their utilization. In consideration of your credit score, creditors look at how much of your available credit limit you’re using at any given time— anything around 15% to 30% is pretty good. When you’re using more than 30%, creditors tend to get a little nervous.
“In your rebuilding time, it’s worth keeping a close eye to keeping everything under that 30% line each month,” says Moriarty. “It shows you’re responsibly managing the amount that’s been extended to you – and could even handle more in the future!
Want to learn more? Then check out our recent blog post: 15 Tips for Improving Bad Credit.
Brett Graff (@BrettGraff) has been seen writing and reporting on money and personal finance in The LA Times, Yahoo! Finance, Cosmopolitan, The New York Times and the Fiscal Policy Institute, to name a few. Brett also provides her insight in the column, The Home Economist, which is nationally syndicated and published in newspapers all over the country. Her book “NOT BUYING IT: Raising Happier, Healthier & More Successful Kids” is now available!
Kerri Moriarty is part of the founding team at Cinch Financial (@CinchFinancial), a Boston-based startup building autonomous fiduciary software. Prior to Cinch, she worked as a financial advisor helping individuals plan their financial lives in the long and short term. Being one of those mysterious millennials, she manages most of her life across 5-6 apps on her phone and recognizes no such technology exists for her everyday financial decisions. Big companies have CFO’s working for them – why shouldn’t you? That’s where Cinch comes in.