Consumers with bad credit (credit scores under 620) have a difficult time borrowing. Interest rates are high, and financing is hard to come by. For those without assets to put up as collateral for a loan (such as a car that can be repossessed if they don't pay up), it's even tougher. Yes, there are advertisements for unsecured personal loans for people with bad credit.
But are there actual loans available to real people?
Personal Loans for Bad Credit: Why It's Hard to Find
Unsecured loans for bad credit are hard to find because the default rate is very high. Personal loan lenders' profit depends on managing the expected default rates associated with different groups of loan applicants. This chart from the FDIC shows expected default calculations for a group of unsecured borrowers. They divide the number of non-defaulters by the number of defaulters to come up with the odds of default for each FICO group.
From this, it's apparent that borrowers with FICOs under 600 default at approximately a 50 percent rate (for every hundred borrowers, 50 default, so according to the FDIC formula, 50/50 = 1.0), while those with scores of 700 default at approximately a five percent rate (95/5 = 20).
Obviously, for a lender to make the same amount from a group that defaults at a 50 percent rate as it would from a group which pays as agreed 95 percent of the time, the interest rate must be higher. Here's how that might work:
- Lender wants a 5.0 percent return, so for every $1,000 loaned, it needs to get back $1,050.
- Prime borrowers repay 95 percent of the time, so for every $1,000 loaned, $950 is repaid.
- The interest rate needed to get $1,050 back from the $950 is 11 percent.
See how this changes when the default rate hits 50 percent.
- The lender still wants $1,050 back for every $1,000 loaned.
- Half of Grade F borrowers default, so for every $1,000 loaned, only $500 is repaid.
- The interest rate required to return $1,050 from $500 is 110 percent!
That's why for people with poor credit scores, finding a personal loan is difficult-- lenders either can't or don't wish to charge such high rates, and they do want to stay in business.
Finding a Personal Loan for Bad Credit
There are personal unsecured loans out there for people with bad credit, but they are limited. First, offers are likely to come with high rates and rather low loan amounts. (Lower loan amounts are mo re likely to be repaid.)
Applicants who are approved have enough documented income to afford the loan, regardless of its interest rate. Consumers with poor scores may find personal loans by completing a short LendingTree request and seeing their offers. They can also get their free credit score from LendingTree and then check out offers from lenders based on that score.
For people with bad credit, another possible source is their credit union or local bank, if the institution offers something called a "second chance" loan. The borrower is required to have a checking or savings account with the lender, and often automated payroll deposit as well. Loan amounts are small, generally a few hundred dollars, and terms are short -- about 12 months.
Other offers of personal loans with bad or no credit are often not real personal loans. Instead, they might be payday loans or check advances, which are secured because they make borrowers write a check upfront, which will be cashed later. If the check bounces, the borrower may be liable for all kinds of civil and legal penalties, including jail time in some states. Other so-called bad credit personal loans are secured by the title to the borrower's vehicle, and the car may be repossessed if the loan is not repaid. These loans are not only secured, they have extremely high rates and fees -- 400 percent or higher is common.
For people with poor credit scores, unsecured loans are available but not easy to find. LendingTree.com is a quick source for available rates and terms at all credit levels.