Make Sure Your Bad Credit Loan Has Payments You Can Afford
Short-term loans that require lump-sum repayment are very difficult for most people to repay on time, trapping them in a predatory cycle of debt.
There’s no perfect solution for borrowing money. No matter what decision you make, every single loan or credit card you take out is going to have downsides—or at least some manner of risk. Even borrowing money from friends and family isn’t a perfect solution. The dangers might be more social than financial, but failing to pay that money back could still get you in big trouble.
When you’re borrowing money and you have bad credit, however, those solutions get even less perfect. Personal loans and credit cards get more expensive and the risks become greater. Lots of bad credit loans out there could even trap you in a predatory cycle of debt. A poor credit score gives you fewer lending options, which means certain lenders can and will take advantage of you.
It’s a bit difficult to boil down any lending decision to a single factor, but with bad credit loans (and any loan, really) there is one element that stands head and shoulders above the rest. If you’re going to take out a bad credit loan, make sure that it has payments you can actually afford. If you take care of that, most everything else should fall into place.
What is a bad credit loan?
In basic terms, bad credit loans are the types of loans available to people with poor credit. While there is no exact definition of a “bad” credit score, it’s safe to say that any score under 630 qualifies as subprime or poor credit. People with scores in this range will not be able to take out personal loans from traditional lenders, as they are seen to be far too risky.
Bad credit loans have much higher interest rates than traditional loans. This is because borrowers with poor credit scores default at a higher rate than borrowers with high scores. (Your credit score essentially sums up your reliability as a borrower, so this isn’t surprising.) Bad credit lenders have to charge higher rates because they need to account for all the loans they issue that won’t get paid back.
Still, that reality does not excuse the absolutely astronomical rates that some of these lenders charge. And by designing their loans to be paid back all at one time, many bad credit lenders make their products even more difficult to repay.
What are the different types of bad credit loans?
There are four main types of bad credit loans: payday loans, title loans, pawn shop loans, and installment loans. The first three are all “no credit check loans,” which mean that they do not check a customer’s score before lending to them. Some installment lenders also do not perform a credit check, but many others perform a “soft” credit check. These checks do not return as much information as a “hard” check, but they also don’t affect your credit score.
Payday loans are short-term small-dollar loans with an average repayment term of only two weeks—in theory, they are designed to tide the borrower over until their next paycheck, hence the name. While the rates for payday loans seem reasonable, they add up to an average APR that’s well over 300 percent. For instance, a 15 percent interest charge for a two-week payday loan translates to an APR of 391 percent. Payday loans are designed to be paid off in a single lump sum, and are sometimes referred to as payday “cash advances.”
Title loans have a typical repayment term of one month and an average APR of 300 percent. Unlike payday loans, which don’t require any collateral, title loans are secured by the title to the borrower’s car or truck. Despite only giving borrowers a fraction of the value of their car, title loans usually have higher loan amounts than payday loans. If a customer cannot pay back their title loan, the lender can repossess the vehicle and sell it to cover their losses.
Pawn shop loans are another type of secured bad credit loan. For collateral, they use a person’s valuables, stuff like jewelry and electronics. Pawn shop laws vary widely from state-to-state, but the standard term for a pawn shop loan is one month. The APRs for these loans can vary anywhere between 15 and 240 percent. Like title loans, failing to pay back a pawnshop loan means forfeiting your collateral.
Installment loans are structured more like traditional personal loans. Instead of being paid off all at once like payday, title, and pawn shop loans, installment loans are paid off in a series of regular payments. The rates for installment loans are oftentimes lower than payday loans, though this varies from lender to lender. Many installment loans are amortizing, which ensures that every payment goes towards paying off both the interest and the principal.
Lump-sum repayment makes many bad credit loan payments unaffordable.
Here’s a thought experiment: If you took out a $400 payday loan, and two-weeks later you had to pay back $500. Would you be able to afford that? Even with an upcoming paycheck to draw from, coming up with that much money at once would be difficult. And if you could make that payment, there is a good chance that it would dramatically impact the rest of your budget. The hole it makes might be so big that you end up having to take out another payday loan to cover your bills.
Unfortunately, this isn’t a thought experiment for millions of Americans. It’s a reality. According to a study from The Pew Charitable Trusts, only 14 percent of payday loan borrowers have enough money in their monthly budgets to afford their loans. This shortfall is partly due to the loans’ lump-sum repayment terms, which force borrowers to pay their loan off all at once.
The same can be said for title loans, but with even more dire consequences for borrowers who cannot repay. In many states, payday and title lenders are allowed to roll over their customers’ loans, which means that they charge the borrower additional interest to extend the loan’s due date. Borrowers usually have to pay the interest already owed on the loan, but that payment doesn’t actually reduce the total amount that they owe. Others pay their loan off and then immediately take out a new loan to pay for necessary expenses.
An installment loan is probably your best option.
This cycle of rolling over or reborrowing a loan quickly turns into an outright cycle of debt; consumers have just enough money to pay off the interest owed on the loan, but not enough to pay down the principal. By extending the due date over and over (or taking out new loans soon after they pay their old ones off), these victims of predatory lending find themselves trapped in a system that slowly sucks their bank account dry.
These people would be better off with a bad credit installment loan. Instead of being stuck paying only the interest on their loan, every payment they make would go towards principal and the interest. The more payments they make, the less money accrues towards the interest, which means that a larger and larger portion of each payment goes towards the principal. Also, with smaller payments made at regular intervals over a longer period of time, there is much better chance that those payments will fit into the borrower’s budget.
Of course, an installment loan with unaffordable payments isn’t a great idea either, so you should make sure to do your research before taking out any kind bad credit loan. Check out the customer reviews and the BBB page for any lender you’re considering, no matter if they’re a storefront lender or a website with online loans.
While an installment loan will likely be more affordable than a payday or title loan, it all comes down to what your budget will allow. Any loan that has payments beyond what you can manage is a one-way ticket to a cycle of debt or even bankruptcy.
To learn more about living with bad credit, check out these related posts and articles from OppLoans:
- How to Survive in a Banking Desert
- Is the Credit Blacklist a Real Thing or an Urban Myth?
- Is Bad Credit Contagious?
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