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If your credit report bears some bruises, you may doubt your ability to get a loan of any kind. Getting a loan with bad credit can be a challenge, but the good news is that many financial institutions are willing to lend to people who have less-than-healthy credit histories and lower credit scores. Here's how you can borrow money from a reputable lender when you have bad credit, and why you may want to improve your scores before you start the application process.
How Bad Credit Affects Lending Decisions
Credit can be considered "bad" when a credit report contains information that tends to be unattractive to lenders. Maybe you're close to the limit on your credit cards, you've made late payments, you've defaulted on financial obligations, you have accounts in collections or you've filed for bankruptcy. When you apply for a loan, the lender may review your credit reports, and this type of activity can be seen as a red flag. It can make them worry that you won't manage a new loan responsibly.
Most lenders also check credit scores, such as those produced by FICO and VantageScore. Credit scores are based on the information listed on your credit reports. They generally range from 300 to 850, with higher numbers predicting less credit risk. If your scores are low because your credit reports contain negative activity, they will impact a lender's decision.
Just what are considered low and high credit scores depends on the lender and changes over time, but in general, FICO® Scores* of 300 to 669 are very poor to fair; 670 to 850 are good to exceptional. VantageScores of 300 to 600 are very poor to poor; 601 to 850 are fair to excellent.
When credit scores are at the bottom of the scale, a loan will likely cost more because a lender will be taking on more risk, and may in turn charge a higher interest rate. To know the difference, plug the numbers into a loan calculator:
- Cost of a loan with bad credit: If your credit scores are in a "needs work" category, a loan's interest rate may be 29.99%. A $10,000 loan with a five-year term and payments of $323.47 will result in total interest costs of $9,408.35.
- Cost of a loan with good credit: On the other hand, if that same loan had a 5.95% interest rate, the payments would be just $193.10, and the total interest costs would be only $1,585.74. Not only would the monthly outlay be significantly less, but it would save $7,822.61 in accumulated interest!
Getting a Personal Loan With Bad Credit
To obtain a personal loan with bad credit, you'll need to approach the process strategically:
- Check your credit reports. This will show you what the lender will see. Also obtain your credit scores so you can search for a loan that is within reach.
- Research bank options. A mailed solicitation is just the tip of the lending iceberg. To get a feel for bank loans that are available to people with bad credit, search the internet to compare offers. Online lenders and banks offer a wide range of loan terms so it's generally worth it to shop around.
- Look into a credit union. If the interest rates offered by banks are too high for comfort, consider a credit union loan. As nonprofit financial institutions, they tend to be more flexible regarding loan eligibility, and may offer preferable rates to members.
- Gather application information. To apply for any loan, you'll have to provide plenty of information, most often including:
- Your annual income, the name of your employer and the number of years you've been at your job
- Your Social Security number
- Your driver's license or state identification
- The amount of any outstanding debt you hold
- An overview of your household expenses
- Whether you rent or own your home
- Apply for one. Once you've identified the loan you like, you're ready to apply. Start by applying for the loan you're most likely to be approved for, instead of applying en masse. An overabundance of hard inquiries in a short span of time will temporarily lower your credit score, decreasing your chances (and increasing the interest rates) even further.
Consider Improving Your Credit Before Applying
If it's possible to wait and improve your credit before applying for a loan, do so. You will have a greater number of loans from which to choose, and the interest rates will be more favorable. The credit report you have will show what you need to work on. Here are a few common culprits.
- Poor payment history: Delinquencies will drop off your credit reports after seven years, but pay all accounts on time in the meantime. As steady payments stack up and you maintain good credit habits in other areas, your credit scores will likely rise.
- High credit utilization: If your credit cards are maxed out and you can't delete the balance, ask your creditors to increase your charging limit. If they do, don't add to the debt—instead, develop a plan to quickly pay what you already owe.
- Collection accounts: Satisfy debts that have been taken over by a collection agency. A bad debt that you've paid in full looks better than an unpaid one that's still being pursued.
You may also add utility and cellphone accounts to your report. Such payments aren't automatically listed, but by signing up for Experian Boost™† , they will start to appear and will help rebuild your credit. As your credit rating escalates, so, too, will your loan opportunities. Even better, the cost to borrow will dramatically decrease.
Of course there may be times when you need a loan before you have the chance to shift from bad to good credit. Therefore, choose it carefully and manage it perfectly. Always send payments by the due date. Eventually the balance will decline, and all those on-time payments may lift your credit rating.