The best loans for bad credit? Ones that can help you build credit
Bad credit can make getting a loan costly and difficult. But landing a loan with bad credit can be a way to help rebuild your credit, which could help you qualify for better interest rates and terms the next time you need to borrow.
Bad credit can make borrowing difficult and expensive — but not necessarily impossible.
There are times when you may not have cash on hand to pay for a larger expense, whether it’s purchasing a new car, consolidating credit card debt, paying off medical bills or completing home repairs.
And that’s when you might consider getting a loan. But if you have bad credit, this process isn’t always easy and can be pretty costly in terms of the interest you’ll pay.
Still, there are several things you can do to help get a loan — and to make sure taking on new debt actually can help rebuild your credit, rather than harm it further.
Can I get a loan with bad credit?
First, it’s important to understand that each lender looks at credit differently. Generally, if you have VantageScore 3.0 credit scores between 300 and 649, it’s considered poor credit, while FICO defines poor credit for FICO® Score 8 as scores between 300 to 579.
According to FICO, for FICO® Score 8, fair credit can range between 580 and 669 on a scale of 300 to 850. According to VantageScore Solutions, for VantageScore 3.0 credit scores, which also use a range between 300 and 850, scores are classified as fair if they fall between 650 and 699.
Lenders will likely use your credit scores to help determine how risky it is to lend you money, what type of loan you qualify for and the interest rate you’ll receive.
But even if your credit is less than stellar, financial experts say, it’s still possible to get a loan.
Consider rebuilding credit
Before you apply, consider taking steps to help improve your odds of getting approved and chances of getting a less costly loan. Potential lenders will run a credit check before granting you credit, so it’s a good idea to check your own credit first to get an idea where you stand.
Chris Scott, founder and chairman of Opulent Credit Builders, a company based in Chicago, says that if you identify inaccurate negative items on your report, you can dispute the incorrect information and try to get the errors removed.
Scott also advises his clients to consider secured credit cards, which require you to give the card issuer a deposit that may help determine your credit limit. Getting a secured card and using it responsibly — making payments in full and on time for at least a few months — may help improve your credit, which could in turn give you a better chance at a lower interest rate for a loan. Just make sure your credit card issuer reports to all three major consumer credit bureaus — Equifax, Experian and TransUnion — so that this good credit behavior is reflected on your credit reports for lenders to see.
If you can’t wait to get a loan and don’t want to open a secured card, there are a couple of loan options you can explore.
Loan options for people with bad credit
Two of the best loans for bad credit are credit-builder loans and personal loans. If used wisely and repaid as agreed, both types of installment loans can help you improve your credit profile.
These loan products are specifically designed to help people build credit. Credit unions are a source of credit-builder loans, but you may also find other financial institutions, including online lenders, offering them.
With a credit-builder “loan,” you essentially prepay the loan. The lender holds the funds in a savings account you can’t access until all your loan payments are complete. You’ll pay off the loan just as you would with any other loan, the loan term usually ranges between six to 24 months. The lender reports your credit activity to the credit bureaus, so that as you consistently make your monthly payments on time and in full, it can help you establish a positive credit history and gradually improve your credit.
A personal loan is another option to consider if you have poor credit. You can use a personal loan for different general purposes — paying for a major purchase (like a wedding), consolidating high-interest-rate credit card debt, or covering an unexpected cost.
But personal loans don’t work the same way credit-builder loans do, and using them to improve your credit can be tricky if you don’t practice good credit behavior. Just as with other types of consumer debt, you need to make payments in full and on time according to your loan agreement.
What’s more, poor credit can mean you pay a higher interest rate for a personal loan than you would if you had good credit. So a personal loan with bad credit scores can cost you more over time than the same loan would if you had higher credit scores.
One credit benefit of a personal loan though is that it can help to diversify your credit mix, which accounts for 10% of FICO® credit scores. Paying off the loan faster also can help to lower your debt-to-income-ratio.
Your current debts account for 30% of your credit scores, so paying off more of your outstanding debts and using less credit can increase your scores over time.
Other loan types: Proceed with caution
When you’re trying to use credit wisely to improve your credit, some types of financial products can actually hinder your efforts.
Payday loans and title loans are two types of short-term, high-cost loans that can deliver fast cash when you need it, but they also come with the possibility of long-term debt. And adding to your debt can cause further harm to your credit, which can get even worse if you have trouble making payments on these high-cost loans.
Payday loans generally give you a loan term of two to four weeks from the initial loan date. The small amount — often less than $500 — may not seem much to repay in that time until you consider the fees and interest that come with the loan.
The interest on some payday loans can equate to an annual percentage rate of nearly 400%, according to the Consumer Financial Protection Bureau.
For a title loan — another high-cost loan for a small amount — you agree to use your car’s title as collateral for the loan. You typically have 30 days to repay the loan amount. If you fail to repay, the lender can take possession of your vehicle. In a 2016 report, the CFPB found that one in five title loan borrowers actually had their vehicle seized by the lender.
Scott says that with any type of consumer loan, it’s important that you read the fine print and not take out more than you need — even if you’re approved for a higher amount. It’s also crucial to understand the loans terms, he says, which will include details on the interest rate and the length of the loan. For example, a personal loan could come with a term of 36 months and an interest rate that can be 10% or more.
Understand what this means in terms of your monthly payment and what the loan will actually cost in total, with interest and fees, before you sign on the dotted line. Taking on a loan that you can’t afford to pay won’t improve your credit — it’s likely it’ll only hurt it.
According to Experian, about 21% of Americans have bad credit — so know that even if you’ve made past mistakes that affect your credit scores, you’re not alone.
The important thing to remember is that bad credit (or no credit) doesn’t have to be permanent — there are ways to improve your credit. If you take out a loan, a credit card or have other forms of consumer debt, making on-time payments, keeping your balances low, and disputing any errors on your credit reports can help improve your credit.
But continuing to practice any habits that may have led to bad credit in the first place won’t lead you to financial freedom, instead making it more expensive — and more difficult — to borrow money.