Interest, Principal, Collateral: Understanding loans
Every loan has three basic parts, even bad credit loans:
- Principal: Short for principal sum, the principal is the amount of money that is loaned to you and added to your account.
- Interest: Interest is the fee paid to the lender for allowing you to borrow money. Interest on loans is usually shown in APR, which stands for annual percentage rate.
- Collateral: Collateral is the guarantee that a borrower puts on account. If the borrower does not repay the loan, the lender can claim the collateral to pay the debt.
With a bad credit loan, you usually borrow a small amount ($100 to $1,500), which is the principal of the loan.
When you sign for the loan, the lender must tell you the interest rate. With a bad credit loan, the loan is designed for 'high risk' users with bad or no credit. The lender does not trust you to repay the loan quickly or on time. So they assign a high interest rate so that they can make money if you can't repay the loan. If you repay the loan, you get a good mark on your credit record and may not have to pay as much in the future.
If you'd like to borrow money for lower rates, you should focus on improving your credit score and paying off current debts. If you start to improve your credit, you will no longer have to pay the high interest rates of a bad credit loan.
You can also lower the price or interest rate of any loan, even a bad credit loan, by putting up collateral for the loan. Collateral is property or cash or an even post-dated check (in the event of a payday loan) used to guarantee your debt. If you cannot pay off the debt, the lender can claim your collateral as payment for the debt.
If you put up collateral for a bad credit loan, it changes from being an unsecured loan to a secured loan. The interest rates are a little lower for secured loans, even they are still bad credit loans.
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Regulation of Bad Credit Loans
Because bad credit loans tend to have high interest rates, most states in the US are moving to regulate bad credit loans and payday loans.
Bad Credit Loan/Payday Loan Laws in Illinois
Although loan laws vary from state to state, we have used Illinois to show the laws for that state.
In Illinois, bad credit lenders cannot charge more than $15.50 for each $100 borrowed. They can also lend you no more than $1000 or 25% of your income.
Lots of bad credit loans have very high interest rates, much higher than the 15.5% shown above ($15.5 out of $100 is 15.5%). This is because the term for the loan is just 2 weeks (from payday to payday) and the interest rate is presented in APR (annual percentage rate). The maximum APR of a 2-week payday loan in Illinois is 403%!
Illinois allows you only 2 loans at a time. This is because bad credit loans tend to be very expensive and it can be easy to get into debt.
Before signing for any bad credit loan, make sure to review the terms and conditions and fees of the loan. Also, some states do not permit bad credit payday loans.
States that do not permit payday bad credit loans:
- New Hampshire
- New Jersey
- New York
- North Carolina
- West Virginia
If you’re in these states, you may have to find a different option to get cash quickly other than payday loans.
Typically, a bad credit loan supports smaller purchases. Most kinds of financing offered to consumers (furniture financing, computer financing) can be considered a bad credit loan.
Bad credit loans are also used to cover the gaps between paydays (hence, payday loan).
Bad credit loans can provide you with cash to avoid:
- Overdraft fees ($35)
- Bounced checks ($25)
- Late fees ($20 to $25)
- Reconnect fees ($45 to $65)
While payday loans are expensive compared to other types of loans, they are less expensive than paying the above fees for lack of money. Overdraft fees are especially nasty: you may end up paying $35 for $1 negative balance. Even if you're paying these fees once per $100, they're much more expensive than the interest from a bad credit loan.
Aren't interest rates low?
Yes, interest rates are low – but not for bad credit loans. Interest rates are lower, overall, but these low interest rates tend to apply to auto loans, home mortgage loans, student loans, and other types of loans.