Bad Credit Loan Alternatives: Borrowing and Payment Options
A low credit score can make it pricier and/or harder to find loans, but it won’t tell you which loan could work for you. Consumers have multiple credit scores, and lenders have the choice to use different scoring models, credit reports, and even their own underwriting guidelines. So, an “average rate” or a score that is advertised as a cutoff will not reliably predict how a loan will be underwritten.
The question you should be asking is not, “Where can I get approved?” The question you should be asking is, “How can I cover this cost for as cheap as possible with payments I can afford?” The answer to this question could be payment plans, financial assistance, small dollar loans, or even personal loans that are structured to fit your budget. It could also mean putting off the expense, rather than taking on additional debt.
Key takeaways
- No universal metric is used to diagnose credit decisions as “bad.” The models and criteria are different for each lender.
- When financing existing obligations, be sure to inquire with the biller about hardship assistance, revised due dates, or payment plans.
- Installment loans give the borrower the ability to make payments that are scheduled; however, having scheduled payments does not, by itself, lower the overall cost of the loan.
- Collateral may lower the cost and increase the likelihood of a loan being approved. However, collateralized loans may make a borrower’s assets available for loan recovery in the case of default.
- Opening a new credit line for the sole purpose of building a credit score may incur fees and an unwarranted expense on the borrower’s budget.
A credit line that has “guaranteed approval” and requires an upfront fee is a warning sign of an advance-fee loan scam.
Decide whether the problem requires cash, time, or debt relief
Different problems require different solutions. For a payment that is due before you receive your next paycheck, you can request a due date change. An unresolved medical debt should be reviewed before it is put on a credit line. If you have several existing debts, nonprofit credit counseling may help you review your options. A necessary repair may require cash, but it might help to narrow the extent of the repair and get another estimate.
Prior to the account going extremely past due, contact the creditor. Find out what kind of assistance the creditor offers, whether a creditor-financing company charges interest and fees, if the account can be reported to a consumer reporting agency, and what should be expected if a scheduled payment will not be made.
For payment plans offered to cover medical expenses, find out what the terms are, including if there is financing involved, if there is an interest charge, and what insurance will cover. 211 may help you locate services and resources to help with rent, utilities, food, etc., although there is no guarantee that you will qualify for services.
Options to compare when credit is limited
| Option | When it may address the problem | Important limits and risks |
|---|---|---|
| Creditor or service-provider arrangement | The cost of the product or service has been determined. You want to pay the cost over time with smaller payments. | Check the contract for fees, interest, reporting, and collection terms, and whether the contract is with a service provider or lender. |
| Community or government assistance | An expense meets the purpose of the program and the program’s qualification criteria. | Funds may be limited and may require documentation or waiting. |
| Credit-union or bank small-dollar loan | Membership or a banking relationship may provide access to a small-dollar loan. | Terms and conditions apply. Check all costs, overdraft, and automatic payment terms, as loan approval is not guaranteed. |
| Unsecured personal loan | There is a valid expense that requires an upfront payment, and the payment amount can be scheduled after your other, more important expenses. | Having poor credit may impact the loan approval and increase the interest rate. A loan processing fee may also lower your proceeds if it is withheld. |
| Savings-secured loan | This loan preserves your savings habit and requires collateral. | The collateral may be used to pay off the loan if you default. The collateral may be unavailable, and interest and fees still apply. |
| Co-signed loan | A co-signer is someone who will legally be responsible for paying your loan if you don’t. | The co-signer may be required to pay, and late payments may negatively impact both parties’ credit and the relationship between you and the co-signer. |
What to know about loans marketed for bad credit
Loans for bad credit do not follow a fixed structure. Loans can be secured or unsecured, come with varying fees, or require varied repayment schedules. A lender may evaluate several factors, like credit history and reports, as well as your income, existing obligations, the collateral, and the loan amount.
A lender may base their decision on different factors than the customer may expect based on their credit score. The CFPB states that lenders employ various credit scores for different kinds of loans and may obtain information from different credit bureaus. Check the credit report for inaccuracies and remember that a single credit score has limitations. Do not continuously apply for loans just to test whether you meet a lender’s cutoff.
Under federal law, a lender that denies credit because of information in a consumer report may have to provide an adverse-action notice. A lender that uses a consumer report to offer less favorable terms may have to provide a risk-based-pricing notice. The notice may identify the credit reporting agency and describe your right to obtain or dispute information in the report.
Secured and unsecured borrowing involve different risks
An unsecured loan does not provide a lender with a security interest in an identified asset. However, a lender may collect what is allowed by contract and the law. A secured loan contains collateral. Default risk reduction for the lender is achieved at the cost of a specific risk transfer to the borrower.
The considerations with secured and unsecured personal loans include the identification of the collateral and the remedy of repossession, foreclosure, account setoff, or other remedies. Using the title to a vehicle to address a cash flow problem puts an important asset at risk of repossession. The savings-secured loan may avoid this risk, but the pledged savings could also be used to pay off the debt.
Do not evaluate secured and unsecured offers based on APR in isolation. When comparing offers, include the fees and charges, the net amount provided, the repayment terms, and the total amount to be repaid. Consider the value of the collateral separately because it is an asset at risk.
Credit cards and credit-building products solve a different problem
With some credit providers, secured cards or credit builder loans may add information to a credit report when data gets furnished, but neither is automatically an alternative to covering an emergency expense. Secured cards require a deposit and may have fees. A credit builder loan may lock the principal until the loan gets paid off.
Since reporting is voluntary, know which consumer reporting companies get the information and whether positive and negative information gets reported. No service can guarantee an increase in the credit score. If the emergency expense isn’t urgent, it may be more effective to review your credit report, dispute mistakes, make payments on time, and reduce the balances on revolving credit accounts. These actions may help your credit without the assistance of a credit repair company.
How to evaluate a borrowing offer
- Identify net proceeds. The amount you receive may be less than the stated principal if an origination fee is taken out.
- Compare standardized disclosures. Look at APR, finance charge, amount financed, payment schedule, total of payments, etc.
- Compare the schedule to real cash flow. Use real income after taxes and real expenses (not best-case-scenario cash flow).
- See what you can find out about inquiry and reporting practices. Ask if rate checking or application is a soft or hard inquiry and if account activity is reported.
- Know the consequences of default. Look at late and other fees, collection terms, and how the loan will be secured. If the loan has an automatic withdrawal option, consider whether a withdrawal could overdraw the account.
- Confirm the lender and the offer. Make sure you actually know the company’s name, and make sure they are actually licensed or registered to do business in your state before you give them your Social Security number or online banking information.
A smaller monthly payment is not the only factor to determine whether a loan is affordable. A longer loan may have higher total costs than you anticipate. If your income varies, a fixed payment may also be harder to manage. Refusing an unaffordable loan is the right decision.
Protect yourself from misleading promises
The Federal Trade Commission warns the public about advance-fee loan scams that claim to offer credit to everyone. These scams claim they will approve you for a loan for a fee. A real lender may charge an application, appraisal, or origination fee, but no fee will approve you for a loan.
- Do not pay by gift card, cryptocurrency, or wire transfer to receive a loan.
- Be careful with offers that come out of the blue and say you have been approved for a loan.
- Find out how a lender will collect, use, and share your bank account and personal information before sharing information or authorizing access.
- Keep records of the application, disclosures, agreement, payments, and communications.
- Reach out to your state’s financial regulator or attorney general if you are uncertain about a lender’s license or practices.
Frequently asked questions
What credit score counts as bad credit?
There is no credit score that stands out as bad credit across the board. Lenders differentiate by setting their own cutoffs. The range described as bad credit varies across scoring models, and approval and pricing still vary.
Is an installment loan automatically a good alternative?
Not necessarily. Having scheduled payments over a loan rather than a lump-sum payment can be convenient; however, many installment loans can be rather costly. Carefully read the loan terms. You should know the loan amount and fees, APR, total of payments, and the consequences for loan default.
Should someone borrow to improve a credit score?
It depends on the cost-benefit analysis and risk to the budget. A reported account may add positive information to a credit file; however, there is no guarantee of the result, and late or unpaid accounts can negatively affect a credit file. There may be cheaper ways to improve a credit file.
Can a payment arrangement affect a credit report?
It depends on the provider, the account status, and the reporting policy. Is the arrangement going to be reported? In the case of missed or late payments, will it be reported? Can it go to collections?
Bottom line
Bad credit does not mean that personal loans available to you are good loan options and does not mean that you must resort to borrowing. Try asking for assistance from a creditor (if there are bills that you can ask for better payment terms), consider regulated small dollar loans, and only pledge collateral if you know the consequences of a default. The best option is the one that fills the need without putting your family in an unmanageable financial situation.