Bad credit can limit your choices if you want to take out a personal loan or borrow money in any form. You can find personal loans if you have bad credit, but the lower your credit score, the pricier the loan will be.
“People do have options for loans if their credit isn’t good,” says Becky House, education and communications director for American Financial Solutions, a nonprofit credit counseling agency. “But (they must) do the math.”
For anyone seeking a loan, make sure you understand the terms so you can choose the best option with the lowest overall cost. Here’s more about how to get a good personal loan if you have bad credit.
[Read: Best Personal Loans.]
What’s the Minimum Credit Score for a Personal Loan?
When you apply for a personal loan or any type of credit, lenders use your credit score to predict your risk as a borrower.
Knowing your risk plays a part in whether you’ll be approved for a loan and what terms you’ll be offered. Can you get a personal loan with a FICO credit score of 550?
Probably. But each lender varies, using its own ranges for credit decisions.
FICO scores are used in 90% of lending decisions and span from 300 to 850. Here’s how FICO breaks down the score ranges:
— Exceptional is 800 to 850.
— Very good is 740 to 799.
— Good is 670 to 739.
— Fair is 580 to 669.
— Poor is 300 to 579.
Borrowers with higher scores not only are more likely to get approved for a loan but also are likely to get better terms, such as lower interest rates.
Lenders may advertise their loans at a certain rate “on approved credit” or provide a wide range: for example, “from 6.95% to 35.89%.” Borrowers with exceptional credit may qualify for the 6.95% rate, while borrowers with poor credit may have to pay 35.89%.
Someone with a lower credit score is viewed as a higher risk, and lenders charge higher-risk customers more to offset the potential cost of default. Or a lender might opt not to approve a higher-risk customer at all.
What Is the Best Loan for Bad Credit?
The fees, rates, policies and overall quality of loans for people with bad credit can vary widely, and some options are poor choices for borrowers. It’s in your best interest to do your homework before you respond to a sales pitch.
House says a former client nearly took a $1,000 loan that would have been repaid at $200 per month for three years — until a credit counselor pointed out the cost. The borrower would have paid $7,200 and an interest rate of 240% for the loan.
Traditionally, borrowers with bad credit have used co-signers, payday loans or high-interest credit cards, House says. “Now we see a lot of new lenders and new products in the loan arena,” she says.
Here’s what to keep in mind about your options:
Talk to your bank about special programs. “Some traditional banks and credit unions are willing to provide small-dollar loans to people facing hardships,” House says.
Many banks and credit unions also offer credit products to consumers with poor credit scores.
Consider nontraditional funding sources. Peer-to-peer, or P2P, lenders are different from traditional banks. A pool of investors, not a financial institution, funds each loan, and credit requirements tend to be more forgiving.
A drawback of peer-to-peer loans is that they can be costly for borrowers with weaker credit profiles; interest rates may be even higher than credit cards.
Sidestep payday loans. Payday loans are notorious for extremely high fees. Interest rates could be 400%, 500% or higher.
The fees are so high that paying off the loan can be difficult, and borrowers may pay more in fees than the original loan amount. Furthermore, payday loans do not report to credit bureaus or help you build credit.
Avoid title loans. Vehicle title loans use your car as collateral in exchange for quick cash. The lender gets the title to your car until you repay the loan, and if you don’t pay it, the lender could repossess your vehicle.
Interest rates on these loans tend to be 300% to 400%, and you usually have to repay the loan in 30 days.
The inherent risk is that if you don’t repay the loan, you can lose your car. Some title lenders even require a GPS tracker so they can easily find and repossess your car if you default.
[Read: Best Home Equity Loans.]
How Can You Get a Good Loan if You Have Bad Credit?
If you need to borrow money with a less-than-stellar credit score, focus on finding the lowest-cost loans you can qualify for. Before you start your search, you can take these steps to improve your odds of approval:
Request an Alternative Credit Score
One reason that a person can have a low credit score or no score is a lack of credit history. This can be a problem if you pay your bills on time but maintain a cash lifestyle with no debt.
Luckily, a number of alternative credit scoring models developed over the last few years can help people in this situation. Two notable examples are FICO Score XD and the UltraFICO score, now in a limited pilot phrase.
FICO Score XD comes from how you pay cellphone, cable and utility bills, while the UltraFICO score uses your checking and savings accounts to gather data about your financial habits.
“Having some money set aside in a savings account is correlated with bill-paying behavior, even if your balance is only a few hundred dollars,” says Dave Shellenberger, vice president of product management for scores at FICO.
Consumers may be able to opt in to the UltraFICO score in summer 2020, he adds.
Getting prequalified means the lender has done a basic review of your creditworthiness to see if you’re likely to qualify for a loan. Before you submit a prequalification application, make sure that it will not result in a hard inquiry on your credit report.
Prequalification can help you preserve your credit score and reserve a hard inquiry for when you think you have a good chance of approval. Too many hard inquiries in a short span of time can hurt your credit score, which could make qualifying for a loan even harder.
Fortunately, the effect of a hard inquiry on your credit score diminishes after 12 months.
Boost Your Credit Score
A few actions can raise your score relatively quickly — and, in some cases, immediately.
Check your credit reports for costly errors. No one will check your credit report for accuracy on your behalf. You can get a free copy every 12 months from each major credit bureau — Equifax, Experian and TransUnion — at AnnualCreditReport.com.
You also have the right to dispute data and request its removal or correction. You can easily initiate most disputes on a credit bureau’s website, but if an error appears on more than one credit report, you must dispute it with each bureau separately.
Lower your revolving debt balances. “One of the fastest ways to improve your credit score is to reduce your revolving debt,” Shellenberger says.
You’ll want to work on lowering your credit u tilization ratio, or how much of your available credit you use compared with your credit limit. Most experts recommend using no more than 30% of the available credit on any card.
If you have a $400 balance on a credit card with a $500 credit limit, your utilization is 80%, which is much higher than the recommended 30% utilization rate.
You can reduce it by paying down debt, asking for a higher credit limit or applying for another card. But the latter two could be tough to do with a weak credit score.
Time your payments right. Do you have a credit card you use heavily but pay off every month? The balance may be reported when you have not yet made your payment.
As a result, your credit score could reflect high credit utilization, even if you pay off your charges on time each month. Find out when your credit card issuer reports your credit utilization to the credit bureaus and pay off your balance before this date.
Become an authorized user. When you become an authorized user on someone else’s credit card, his or her credit history affects yours. Make sure the person handles credit responsibly, or this strategy won’t help you. Also, you don’t have to use that person’s credit card, even if you’re on the account.
Pay on time, every time. Your payment history influences your credit score more heavily than any other factor. Strive for perfection.
Late payments stay on your credit report for up to seven years, but the older they are, the less they hurt your score. Also, extremely late payments hurt more than slightly late payments.
In other words, a payment that is 30 days late will do less damage to your credit score than one that is 90 days late or a collection account. If you have missed a payment, catch up as soon as possible.
Leave old accounts open. Part of your credit score is based on the average age of your accounts and the age of your oldest account. Try not to close your oldest accounts unless you want to avoid annual fees.
[Read: Best Debt Consolidation Loans.]
What Can You Do if You’re Not Approved for a Personal Loan?
If your loan application is rejected, take a step back to reassess your needs and options. Do not rush to apply for more loans to see what you can get because your credit score may dip after each application.
Depending on why you need the money, a secured loan may be a good choice. This is a loan backed by collateral such as homes, cars, savings accounts or investments.
Some financial experts recommend that a loan secured by your home should only be used to maintain or improve your home. If you need to fix a leaky roof, for instance, this may be a reasonable option to pursue.
If you need a loan not to improve your home but to manage debt and your application is denied, talk to a credit counselor about starting a debt management plan, or DMP. A DMP gives you one affordable monthly payment and repays all your debt in three to five years, plus all the collection calls stop.
Creditors may lower your interest rates or waive certain fees, but you could have to stop using your credit cards. The National Foundation for Credit Counseling is a good place to find a certified credit counselor in your area.
Another option for borrowing may be a cash-out refinance, which could require a lower credit score than what you need for an unsecured personal loan. If you have a good relationship with your bank, talk to a loan officer there about your options, or perhaps ask a family member or friend for help.
But be honest about your ability to pay back a loan, and work on building a savings account to provide a cushion during tough times. “Sometimes people think they need to have thousands of dollars in savings, but even a couple hundred dollars might help you cover a rent shortage or flat tire,” House says.
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Update 03/24/20: This story was published at an earlier date and has been updated with new information.