Will a Bad Credit Loan Impact Your Credit Score?
The impact that a bad credit loan could potentially have on your score will depend on what kind of loan you’ve taken out.
When you’re borrowing money, you usually have more immediate concerns than whether or not it’s going to affect your credit score—doubly so if your score is already lousy and you’re taking out a bad credit loan. In cases such as these, the odds are good that you’re in the middle of an emergency; your credit score is the last thing on your mind!
But that doesn’t mean you should be ignoring it entirely. Your credit score is incredibly important to your overall financial wellness. With a strong score, after all, you wouldn’t have to be relying on bad credit payday loans and cash advances to bridge those gaps in your cash flow.
And when it comes to your credit score, some bad credit loans have advantages over others.
The three types of bad credit loans.
Before moving on, it’s important we cover the three basic types of bad credit loans. All these loans are made available to people whose low scores lock them out from traditional lenders.
Unlike traditional loans, these don’t require a credit check, which is why they’re also (very creatively) known as “no credit check loans.”
Since they are being offered to people whose scores make them less creditworthy, these loans come with much higher annual interest rates than traditional personal loans. This is to protect the lender from the much higher default rates that they’re going to encounter.
However, these rates can vary wildly depending on where you live and who you’re borrowing from. It might depend also on whether you’re applying for a loan at a local storefront lender or if it’s an online loan.
Payday loans are the most common type of bad credit loan. They are short-term, small-dollar loans, with an average repayment term of only two weeks and average principal amounts of a few hundred dollars.
Your typical two-week payday loan has an interest rate of 15 percent, which seems pretty good until you realize that it adds up to an annual percentage rate (APR) of 391 percent!
Oh, and if you see an ad for a “cash advance” loan, then you should know that it’s basically just a payday loan being advertised under a different name.
Title loans are similar to payday loans; their one-month average repayment term is slightly longer and their average principal amount is higher, but their average 300 percent APR is right in line with their short-term cousins.
They do, however, come with one crucial difference: Title loans use the title to your car or truck as collateral. So if you can’t pay the loan back, this gives the lender the right to repossess your car and sell it in order to make up their losses. Yikes!
Lastly, you have bad credit installment loans. These loans come with much longer repayment terms, usually anywhere between six to 36 months, and they often come with higher principal amounts as well.
Unlike payday and title loans, bad credit installment loans aren’t designed to be paid back all at once. Instead, the borrower pays them back in a series of regular installments. That’s how they got their name.
How do regular loans affect your credit score?
With regular loans, there are two ways that they affect your credit score. First, the lenders report the amount that you borrowed, which is added to the “Amounts Owed” portion of your score.
Second, lenders report whether or not you make your payments on time (or miss payments entirely); that information is included in your Payment History.
Both your Payment History and your Amounts Borrowed are incredibly important to your score. In fact, they are literally the two most important factors.
Your Payment History accounts for 35 percent of your overall score and your Amounts borrowed makes up another 30 percent. Together, they account for 65 percent of your score!
For reference, no other factor accounts for more than fifteen percent.
Do bad credit loans affect your score?
With payday loans and title loans, it’s almost guaranteed that your lender isn’t reporting any of this information. On the bright side, this means that you won’t get dinged for adding onto your total debt load.
On the not-so-bright side, any on-time payments you make won’t get added to your score, either. You won’t be getting credit for being a responsible borrower!
With installment loans, the odds are much better that your lender is reporting payment information to the credit bureaus, which means that those payments are being reflected in your score.
If you make all your payments on a bad credit installment loan from a lender like OppLoans, you could end up helping your credit score!
Defaulting on any loan will hurt your score.
Even if a payday lender isn’t reporting information to the credit bureaus, there is one way that those loans will end up affecting your score. Spoiler alert: It won’t be good.
If you default on a payday loan—which means that you fail to pay the loan back—then the lender will likely end up selling it to a debt collector. Once the loan is with them, that debt collector will report it to the credit bureaus as an open collection account.
This is going to hurt your score. The entire point of the credit scoring process is to express whether or not a person can be trusted to pay back the money they borrow. An open collection account on a person’s report is proof that they borrowed a loan that they then didn’t repay.
The only exception here comes with secured bad credit loans like title loans and pawn shop loans. If the lender is able to recoup their losses by repossessing your car or selling your pawned item, then they probably won’t need to notify a debt collector or report your account.
Take care of your credit score.
There is no miracle cure for a bad credit score. While paying down a large amount of your outstanding consumer debt (like personal loans and credit cards) will likely result in some immediate improvement, you’ll still need a solid payment history to shore things up.
While payday can only ever hurt your credit score, a bad credit installment loan can help, so long as you stick with the right lender and make all your payments on time.
You might not be thinking about your credit score when you’re looking for a bad credit loan, but ignoring it entirely is probably not the best idea.
To learn more about how you can improve your credit score, check out these related posts and articles from OppLoans:
- How to Build Credit When You Have No Credit at All
- Want to Raise Your Credit Score by 50 Points? Here Are Some Tips
- Credit Utilization Ratio: What It Is, Why It’s Important, and How to Master It
- No Credit Card? Here Are 6 Ways You Can Still Fix Your Credit Score