What Is Bad Credit?
First, what exactly is bad credit and do you have it?
To be blunt, if you have bad credit, you probably already know it. To be specific though, a bad credit score is one that is below 580. When you have a score below the 580 range, credit options can become tough and you may need to turn to what is called a “sub prime’ lender. This is a lender who is willing to finance those who do not have good to excellent credit.
While it is nice that there are still lenders willing to finance you with a poor score, using one of these lenders does not come without a certain amount of risk.
Risks With Bad Credit Financing
Before you take on that credit obligation, let’s look at the negatives that go with this type of financing.
A bad credit loan will have high interest rates, there is no way around this. With a low credit score, you will be a much higher risk to a lender and lenders taking on these kind of risks expect a few loans to be defaulted on. To take that risk and still be profitable, they need to make up for it with higher interest rates. In a perfect world, these interest rates would align with ethical standards, but reality is much different. Effective interest rates for these types of loans can get over 100 percent, so be very careful.
Along with the high interest comes high fees. This could be simply a high fee for late payments or it could be a hefty origination fees. In any case, your lender is required to inform you about loan fees and they should be included in the APR or Annual Percentage Rate. This is the total rate of interest when all fees are included with the loan.
No Benefit To Credit Score
One last negative is that if you pay on time, there may be not benefit to your credit score. With traditional lenders, your good payment information is reported to credit card bureaus. This can raise your credit score over time. Many bad credit lenders do not bother reporting to the bureaus, unless you default that is.
How To Avoid The Risks
Luckily, avoiding the risks of bad credit loans is easy, but you need to make sure that you read all of the loan details. Unfortunately, many borrowers fail to do this and wind up trapped with a bad loan that is hard to manage. Here are a few things to consider before signing on the dotted line.
Is The Interest Rate Too High?
The interest rate will obviously be high, but make sure that it is not too high. Look at the APR, which takes fees into account, and determine this for yourself. any rate with an APR greater than 20 percent should be looked at with skepticism.
Are Payments Automatically Deducted?
This is a red flag because it takes away a lot of your control and can lead to problems. While many lenders will offer a discount for automatic payments, be cautious if it is a requirement. Automatic payments could easily leave your account overdrawn and make you susceptible to late fees and other charges.
Can You Find Another Option?
Last, but not least, look for another option before you commit. Turn over every stone looking for a cheaper financing alternative. In addition, consider whether you really need the money that you are after. If it is for something that is a non necessity, you may be better off passing on the purchase.