15% of Americans have bad credit, probably because most borrowers don’t understand how credit works until after the damage is done and have been told by lenders, “Sorry, we don’t make loans for people with bad credit.”
Bad credit is usually determined by your credit score, which is a number derived from your credit report. Your credit report documents your repayment habits and your history with debt. Every time you borrow money, your lender can report your payment history and how much you borrowed on your credit report. Late payments and excessive use of credit can lower your credit score.
Even if you don’t borrow money - maybe you just skipped the rent or your utility bill for one month - negative information can still be recorded on your credit report.
Bad credit borrowers have a credit history that affects their credit rating, and their scores usually fall below 619. Even scores between 620 and 639 aren’t considered that good.
Unfortunately, bad credit makes it more difficult to obtain loans, and some lenders won’t provide loans to people with bad credit at all. Lenders are reluctant to lend to people with bad credit because their credit reports and credit scores suggest they are irresponsible with their debts, which increases the risk that lenders will not be repaid.
This leaves borrowers with bad credit limited options - and more costly options. If lenders are willing to lend to people with bad credit, they usually charge higher interest rates in an effort to make up for any potential losses. Though higher interest rates don’t seem like a big deal, it can increase your monthly payments and actually make your loan much more expensive overall.
Imagine you want to buy a home for $300,000 for a fixed rate. (A fixed rate mortgage loan charges the same interest rate throughout the life of the loan.) The APR (or annualized interest rate) your lender offers will vary, depending on your credit score. Usually, the better your credit score, the lower your APR will be.
Good Credit: $400,000
Bad Credit: $400,000
Good Credit: 30-Year Fixed
Bad Credit: 30-Year Fixed
Good Credit: 4%
Bad Credit: 7%
Good Credit: $1,910
Bad Credit: $2,661
Overall Interest Paid
Good Credit: $287,478
Bad Credit: $558,036
Total Amount Repaid
Good Credit: $687,478
Bad Credit: $958,036
Having bad credit does not necessarily mean you will be offered an APR that is 3% higher than someone with good credit; this table is just an example of how higher interest rates (usually offered to people with bad credit) increases the cost of the loan.
The monthly payment for a mortgage loan at 7% is $750 more than the mortgage loan with a 4% APR. This money could be used for more important expenses.
Not only are the monthly payments higher, but so is the overall cost of the loan. Paying an extra $750 a month for 360 months amounts to $270,000! Think you found your dream house? Consider improving your credit and putting the $750 a month that would have gone to interest towards renovating a dream home instead.
Having high interest rates can increase your monthly payments significantly as well as the overall cost of the loan. Though the table above is just an example, the concept holds true for all types of loans, whether they are car loans, home loans or personal loans.
Understanding that loans are typically more expensive when you have bad credit helps you determine if you want to improve your credit first or if you still want to apply for a loan.
Though many lenders are less inclined to provide loans for people with bad credit, there are still many institutions that provide bad credit loans to accommodate the large number of Americans that have bad credit. Lending to people with bad credit is riskier, but many lenders are still willing to take the risk because they can profit from the higher interest rates they charge.
There are many types of loans available for people with bad credit, including car loans, home loans and personal loans. Lenders will usually charge you higher interest rates if you have bad credit, but some industries charge higher annual interest rates regardless of your credit rating - because they don’t check your credit.
Payday loans are different from other loans available to people with bad credit because payday lenders don’t check your credit score. This means that people with good credit will be charged the same rates as people with bad credit.
Since payday loans are intended for borrowers that have bad credit or no credit history, payday lenders charge a high interest rate. Payday loan APRs average 365%, which is much higher than the 15% APR of your average credit card. Though the APR is much higher than the typical loan, many people have difficulty recognizing this because lenders charge a flat fee over a short time period. So the typical $15 fee for a $100 loan has an APR of 390% because the loan must be repaid within 2 weeks.
Payday loans are expensive, but some people use these types of loans for emergency expenses or to avoid bank charges or late fees that can be much more expensive in comparison. Payday loans provide borrowers a small amount of money ($100 to $1,000) for a short period of time, giving you the chance to cover unexpected costs.
Rollover fees (charges to extend your payday loan) can make payday loans even more expensive, though. This is because you are charged a fixed fee (about $15) every time you rollover the payday loan, which can quickly add up and you might pay $45 to borrow a $100 loan for 6 weeks. Many borrowers struggle to repay the loan once rollover fees are charged, so make sure you repay your payday loan on time in order to avoid additional charges.
Before deciding on a payday loan, make sure you understand all the costs and that you are aware of all your options.