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3 Reasons Why You Should Avoid Bad Credit Home Loans

When you’re strapped for cash or you need to borrow money for a big purchase, taking out a loan can help close the gap. Banks and credit unions are great options if you need something short-term with a low interest rate, but it’s hard to get approved if your credit’s not that great. If your credit score has taken a hit, you may be forced to explore some less attractive lending options. Bad credit loans are designed for people with a less than optimal credit history but there are some serious drawbacks to consider before signing on the dotted line.

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How to Get a Mortgage With Bad Credit

Having bad credit can hinder you from getting a mortgage. But if you’ve dreamed of having your own home, you could try applying for a loan through the Federal Housing Administration or the Department of Veterans Affairs if you were in the armed forces. There are also banks, credit unions and private lenders that offer loans specifically for people with poor credit.

More Risk = Higher Interest

3 Reasons Why You Should Avoid Bad Credit Home Loans

The whole point of bad credit loans is that they’re easier to get approved for than traditional loans if your credit history is spotty because of things like collections, judgments or bankruptcy. Someone who’s got a credit score of 630 probably won’t get far with their local bank, but a bad credit lender is more likely to spot them the cash. Since a lower credit score is usually associated with a higher risk level for default, the lender covers themselves by charging significantly more in interest.

The amount of interest you’ll pay for a bad credit loan really depends on the lending source.

Payday lenders, for example, are known for charging interest rates as high as 400%, while an auto title loan can come with a rate as high as 90%. If you’re trying to buy a home from a lender that deals exclusively with bad credit borrowers, you could be looking at a rate as high as 20%. Compared to a conventional home loan that usually has a much lower fixed rate, you’re paying substantially more to borrow the money.

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Penalties for Default

Since lenders are assuming more risk with these types of loans, they often impose stiff penalties if you miss a payment or default on the loan altogether. Payday loans, for example, usually allow only a very short window of two to four weeks for repayment, based on your regular pay schedule. If you don’t repay the full amount by the cutoff date, the lender may allow you to extend the loan but add on a hefty fee for doing so.

How Bad Credit Loans Impact Your Credit

3 Reasons Why You Should Avoid Bad Credit Home Loans

Taking out a loan can be a way to improve your credit, as long as you’re making regular payments on time. The problem with certain bad credit lenders is that they don’t always report to the credit bureaus so you won’t see any real benefit to your score. This is particularly true for payday loans, since the loan term tends to be fairly short.

On the other hand, if you end up defaulting it can wreak havoc on your score, especially if the lender ends up selling the debt to a collection agency. If the debt collector is reporting the account as delinquent, with multiple late or missed payments, you’ll see your score take a serious nosedive.

Related Article: Dealing with Debt Collectors? Know Your Rights

Bad Credit Loan Alternatives

If you’re considering a bad credit loan, it’s important that you weigh all of your other options first. For instance, asking someone to co-sign on a bank loan can get you better terms as well as a lower rate and you typically won’t pay as much in fees. The only disadvantage is that if you can’t repay the loan, the co-signer becomes responsible for the outstanding balance.

Some of the other avenues you may want to explore include selling off any assets you don’t need, borrowing the money from friends or family, tapping your home equity and peer to peer lending. Like any loan option, they each have their own pros and cons.

Photo credit: ©iStock.com/VMJones, ©iStock.com/Henrik5000, ©iStock.com/-Oxford-

Rebecca Lake Rebecca Lake has been writing about the nuts and bolts of personal finance for nearly a decade. She is an expert in investing, retirement and home buying topics. Her work has been featured on The Huffington Post, Business Insider, CBS News, U.S. News & World Report and Investopedia. As a homeschooling mom of two, she's always looking for ways to make the most of every dollar.
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