A Guide to High-Risk Loans

When you have bad credit, it can be difficult to get a loan, but it’s not necessarily impossible. High-risk loans are designed for bad-credit borrowers and can be a workaround to accessing the funds you need. But there are also risks to consider, like higher costs to borrow and possibly losing any collateral you use to get the loan, if you can't pay it back.

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What are high-risk loans?

In exchange for accepting an applicant who may have bad or no credit, a lender may charge a higher APR, require collateral, or both. So high-risk loans generally cost more, as they shift some of the risk to the borrower. Here are some common types of high-risk loans:

Types of high-risk loans

High-risk loans can come in several forms:

• Secured loans: These loans require you to put up an asset, such as your car or house, as collateral to secure the loan. If you stop making payments or default, you can lose that collateral. The value of the collateral can vary widely, depending on the loan amount. Secured personal loans, mortgages, auto loans, home equity loans and home equity lines of credit (HELOCs) all fall under this umbrella.
• Car title loans: This type of secured loan requires you to give your car title over to the lender until the loan is repaid (or you forfeit your ownership). The amounts are typically small, and they usually have 30-day terms. You’ll also pay high fees and interest. The Consumer Financial Protection Bureau warns that 1 in 5 borrowers who take out these loans have their vehicle seized by the lender, and 4 in 5 can’t repay in a single payment, so they’re best avoided.
• Payday loans: These loans are typically limited to $500 or less, and require you to repay the loan within two to four weeks. Payday loans should be avoided as well, as they come with sky-high APRs of 400% or more and a $10 to $30 charge for every $100 borrowed.
• Bad-credit personal loans: Some lenders specifically offer personal loans for those with bad credit. Keep in mind, however, that the amount you can borrow may be limited for this type of loan.

Am I a high-risk borrower?

Lenders consider those with bad credit (or no credit) to be high-risk. That’s because they either don’t have a proven track record to show that they are responsible borrowers, or they’ve had trouble repaying their debts. Lenders want to see that each borrower is likely to repay the loan.

Here are the specific factors that will impact whether or not you’re considered high-risk:

• Credit score: A FICO score that’s below 580 falls into the “poor” credit category, meaning you’ll find it difficult to qualify for most loans. You can improve your credit score by making on-time payments or simply checking your credit report for any errors dragging down your score.
• Credit history: If your track record shows that you’ve defaulted on debts or made late payments in the past, that will make you a high-risk borrower — especially if those happened recently. Consider setting up autopay to help avoid missing payments. That said, don't rely on auto-pay as it isn't foolproof. 
• Length of credit history: Similarly, if you don’t have a long credit history or no credit history, that’s considered a riskier bet. The lender won’t have enough information to go on to evaluate your credit profile and whether it’s safe to lend to you. However, you can consider taking out a credit-builder loan, which is designed for borrowers with no credit or limited credit history to boost their scores.
• Debt-to-income ratio (DTI): Your DTI is how much money goes toward debt each month divided by your pretax monthly income, expressed as a percentage. Most lenders prefer a DTI of 35% or less. You can lower your DTI by paying off small debts or increasing your income.
• Employment status: If you’re unemployed, this signals to the lender that you may not have a steady source of income with which to pay back a loan.

Check Out: No-Credit-History Loans

Why choose a high-risk loan?

There are a few times when it might make sense to choose a high-risk loan:

• Lack of alternative options: If you have poor credit, or no credit, you may not be able to qualify for traditional loans, so high-risk loans may be your only option.
• Faster access to funds: While trying to get a traditional loan may require you to wait until your credit improves, with a high-risk loan, you may be able to access cash with the credit score you have now.
• Maintain existing savings or assets: Taking out a high-risk loan may allow you to keep assets, such as an emergency fund or car, rather than having to cash out or sell. That can be especially helpful if you require those assets to get to work, or the nature of your work is somewhat unsteady.

Although these reasons are legitimate, it’s always important to carefully evaluate your financial situation before getting any loan, especially a high-risk loan. If you can’t keep up with the payments, you may end up losing your collateral, and damaging your credit.

Learn More: What Are Collateral Loans?

Drawbacks to high-risk loans

There are several important drawbacks to high-risk loans that you need to understand before taking one out:

• Higher costs: High-risk loans often have higher APRs (the total cost of the loan, including interest and unavoidable fees such as an origination fee). So you’ll pay more to borrow, long-term. And payday loans (a common type of high-risk loan) may have exorbitant fees that can balloon the cost of a relatively small debt up to a 400% APR or more.
• Risk of losing collateral: If you have a secured high-risk loan and you fall behind on payments, the lender could seize that asset as a way to ensure it gets its money back.
• Lower borrowing limits: Some lenders will compensate by only offering relatively small loan amounts to those who are considered to be high-risk borrowers. So if you require a large loan, you may not be able to access that if you fall into this category.
• Potential to get trapped in a debt cycle: Payday loans in particular are notorious for carrying high APRs and requiring short repayment terms, so borrowers may need to take out another payday loan to cover those costs, causing the cycle to continue.

If you’re considering a high-risk loan, keep an eye out for predatory lending practices usually associated with payday loans. This can come in the form of extremely high prepayment penalties or aggressive sales tactics by lender representatives such as pressuring you to sign the loan agreement.

Alternatives to high-risk loans

There are other options to consider besides high-risk loans.

• Payday alternative loans (PALs): Offered by credit unions to their members, these short-term loans are legitimate alternatives to payday loans. There are two types of PALs. PALs I offers repayment terms that last up to six months, with loan amounts up to $1,000. You also need to be a member of a credit union for at least a month before you can access this type. PALs II offers repayment terms up to 12 months and a maximum loan amount of $2,000. With this type there is also no waiting period on eligibility. The interest rate for both is capped at 28%, including finance charges, which makes it easier to manage these loans and pay them off.
• “Buy now, pay later” services: With these services, it’s exactly as it sounds. You make your purchase now, and pay later over several weeks or months, depending on the service. Some apps may even let you pay in four installments, interest-free. Some companies may charge fees, either for using their app or if you make a late payment.
• Ask a family member or friend for a loan: A family member or friend may be able to lend you the money you require, and could offer significantly better terms than you’d find through a high-risk loan. This also won’t impact your credit since it isn’t reported to the credit bureaus. The key is establishing the terms and expectations ahead of time, so that there are no surprises should something come up.
• Get a qualified cosigner: If someone you know has good credit and is willing to become a cosigner on your loan application, they can help you qualify for a traditional loan. However, they would be responsible for the loan if you were to stop making payments.
• Seek out credit counseling: Credit counseling can help you get a handle on your finances through advice from a qualified counselor. Since it’s one-on-one, you can dig deeper into your situation and find a path forward that works best for you. Plus, it’s usually either free or low-cost. The Financial Counseling Association of America and the National Foundation for Credit Counseling are solid places to start your search.
• Debt management plan: If you’re trying to get out of debt with a high-risk consolidation loan, you can instead set up a debt management plan with a credit counselor. These payment plans are designed to get you out of debt with a manageable monthly payment to your creditors. However, some debt management agencies may charge fees such as a set-up fee or a monthly fee to use their service.
• Improve your credit over time: Another approach is to focus on improving your credit so that you can qualify for a traditional loan. Some of the steps you can take here include getting a secured credit card or credit-builder loan to establish credit, paying down revolving debt to below 35%, signing up for autopay to avoid late fees, and using a service like Experian Boost to get credit for paying things like utilities on time.

High-risk loans FAQ

Should I get a high-risk loan?

For most people, a high-risk loan isn’t a good idea since it can lead to a cycle of debt, depending on the type. If you do need those funds, however, be sure to closely examine the terms of the loan to ensure you can afford it, and avoid predatory ones, such as payday and title loans.

Can I get a high-risk loan with bad credit?

Yes, high-risk loans are typically an option for those with bad credit. However, you may need a high-value asset to use as collateral in order to qualify for a secured loan, depending on the lender and loan type. Bad credit typically translates to higher costs, such as a higher APR or monthly payment.

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