Having bad credit doesn’t mean you’re a bad person. But your credit history is your track record of how well you use and repay credit. If good credit makes it easier to get loans at good rates, bad credit can have the opposite effect. So what should you do if you need to apply for a loan with bad credit?
According to a 2014 Federal Reserve study, 40% of people surveyed who wanted access to some form of credit didn’t apply for it because they thought they might not be approved. Denial of credit may have been a possibility, but bad credit doesn’t mean you’ll always be turned down for a loan.
Low credit scores? You can still shop around for a loan
Low scores shouldn’t stop you from considering a personal loan when you need one. Credit Karma can connect you with lenders willing to consider loaning money to people with credit scores of 639 or less.
So before you resort to expensive forms of borrowing, like payday loans, let’s look at some things to know about applying for a loan with bad credit.
Credit scores: Your credit GPA
Here’s a comparison to help you understand how credit and credit scores work.
In college, you studied different subjects like history, math, economics and psychology. You received individual grades for each assignment and a grade for your overall performance at the end of the course. At the end of the semester, you’d receive one single score — your GPA — based on all the work you’d done previously in all your classes.
That’s the idea behind your credit reports and your credit scores. Your credit reports contain a list of the money you owe, the details of how you owe the money, and your history in paying it off as agreed. Your credit scores, on the other hand, are more like your GPA. They are calculated based on the information in your credit reports and they help lenders understand how well you’ve managed credit.
When people refer to “credit” as a whole, they often mean both your credit reports and your credit scores. That’s because lenders generally look at both when deciding whether to approve you for a loan. Lenders often look at your credit scores first as a simple snapshot of how trustworthy you are as a borrower.
What exactly is bad credit?
Multiple companies generate credit scores through credit-scoring models. FICO offers many go-to scoring models that lenders can use when evaluating credit applications. Base FICO® scores range between 300 and 850. Here’s how FICO defines the credit ranges based on FICO® 8 credit scores.
- Poor: 579 and lower
- Fair: 580–669
- Good: 670–739
- Very good: 740–799
- Exceptional: 800+
As of April 2017, the average national FICO® score was 700 — the highest the average had ever been, according to FICO. But people with credit scores in the fair to poor ranges (i.e., credit scores less than 670) may have trouble getting approved for some types of loans.
People can have bad credit for many different reasons. For example, if you miss payments, max out your credit cards or have derogatory marks on your credit reports, such as a bankruptcy or a foreclosure, your credit scores could drop.
What factors affect your credit scores?
Different credit score requirements
Lenders can have their own cutoff credit scores. If your scores fall below this cutoff, the lender may be less likely to approve you for a loan. But if your scores are above that mark, the lender may be more likely to open up your credit reports to see your credit history. The lender may then factor in other things, like your debt-to-income ratio, to decide whether to offer you a loan and at what interest rate.
Different types of lenders can have different score requirements for various types of financial products. For example, to get an FHA mortgage with the lowest down payment requirement (3.5%), you’ll need credit scores of 580 or better. Financial institutions like banks or credit unions might want you to have credit scores in the 600s to get a conventional mortgage.
Qualifying for a personal loan with credit scores in the 500s may be difficult or costly. But some alternative lenders, like payday lenders, might not look at your credit scores at all, but can charge very high interest rates.
Can I apply for a loan with bad credit?
Some may think that their low credit scores mean their only option is to use alternative types of loans, such as payday or a car title loans. These short-term loans typically don’t require a credit check, which could make them appear attractive if you think you won’t qualify for a traditional personal loan or credit card.
But these types of loans can be extremely expensive in the long run.
According to a 2014 report from the Consumer Financial Protection Bureau, more than 80% of payday loans are rolled over or followed by another loan within 14 days, keeping people in debt far longer than they may have planned. It’s easy to understand why, given that these loans can have fees that are effectively interest rates averaging 400% APR. Compare that to a typical credit card, which can be around 30% APR at the high end of the scale.
Instead, a better option is to look for lenders that will work with people with bad credit (yes, those lenders do exist, but you need to seek them out). We can help you locate these lenders for personal loans, auto loans, credit cards and even home loans.
And if you can possibly swing it, try saving up for big purchases and emergencies before they happen. That way, you don’t need to worry about taking on debt until it’s absolutely necessary and can instead focus on improving your credit.
How much can loans with bad credit cost?
While you can get a personal loan with bad credit, be aware that you’ll likely have to pay a higher interest rate.
Here’s an example of how you could pay more.
Your car breaks down and you need a personal loan of $2,500 to pay for the repair. If your credit is very good (say, you’ve got base FICO® scores of 740), you might qualify for a three-year personal loan at a 9.33% interest rate — with a monthly payment of $79.88. At that rate, you’ll pay a total of $375.82 in interest over the life of the loan.
But let’s say your credit is poor (base FICO® scores below 580) and you get approved for an interest rate of 35.89%. Now your monthly payment will be $114.35, and you’ll pay $1,616.70 in interest over the life of the three-year loan.
For this $2,500 three-year personal loan, having bad credit would cost you an extra $1,240.88.
Bad credit? You’re not stuck.
The first thing you should know about having bad credit is that it doesn’t have to be a permanent thing. Most derogatory marks, such as late payments, foreclosures and even bankruptcies, will fall off your reports after seven to 10 years.
This means that even if you file for bankruptcy, it’s still possible for you to work toward better credit. Here are some steps you can take toward that goal.
First, check your credit reports. According to a 2012 study by the Federal Trade Commission, about 25% of U.S. consumers found errors on their credit reports that could affect their credit scores. Finding these errors — and successfully disputing them so they are removed from your credit reports — is an easy thing you can do to improve your credit.
How to dispute an error on your credit report
Next, learn what factors go into calculating your credit scores. By working to improve these factors, your overall credit health may improve, including both your credit history and your credit scores. For example, making sure you make your payments on time and pay down your debt (especially credit card debt) can go a long way toward improving your credit.
Trying to secure a loan when you have bad credit can be frustrating. But there could be a ray of hope for you. It may be possible to find reputable lenders who will work with you, even if you have bad credit.
In fact, taking out a personal loan with bad credit and making payments on time may help to improve your credit scores. That way, if you ever need to make a larger purchase like a house, you can have better credit in place.