At some point in life, everyone encounters financial struggles. While for some, these challenges may be temporary, others may find themselves trapped in a perpetual cycle of financial difficulties, particularly when burdened with debt. Escaping this situation can be incredibly daunting.
During such times, high-risk loans can provide a lifeline when resources are limited. However, it’s natural to perceive these loans as risky. We understand that paying off debt can be challenging, which is why it’s crucial to educate those facing financial hardships about the options available to them. In this regard, we have compiled a comprehensive guide that sheds light on high-risk loans, along with valuable information about the associated financial and credit aspects. This guide aims to empower individuals by equipping them with the necessary knowledge to make informed decisions regarding their financial well-being.
What Is a High-Risk Loan?
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A high-risk loan is essentially a loan that is granted to individuals with bad credit scores. Although bad credit scores do not always accurately represent a person’s money habits, it can signify that a person does not manage well with repayments. The risk involved is for the lender in this regard.
These loans are granted to what is known as a high-risk borrower by a usually high-risk lender. The interest rates for these kinds of loans tend to be quite substantial. That is how the company issuing the credit can be sure that they will get at least some of that funds back if not all of it. But the higher interest rates also can make the loans quite risky for the borrower if they are unable to pay it back.
Additionally, these types of loans are unsecured. This means that the lender does not require any collateral or guarantee from a borrower. Collateral refers to a form of a property a lender uses for securing a repayment, such as car title loans. Unlike many corporate banks, these companies will not be able to take valuable possessions or assets such as a house, car, or other belongings.
Again, high-interest rates are how lenders compensate for not having these usual kinds of security that you might find in other types of loan lending, such as a mortgage.
Your Credit Score Explained
The vast majority of high-interest rate loans are given to those with poor or subprime credit rating. So, what does it take to get a bad credit score?
Your three-digit credit score essentially represents how you cope with debt. Late payments, applying for credit, or stretching the limit of a credit card repeatedly are some of the factors that lower a credit score. Limited or even no credit history will also equate to a poor rating for your credit.
A score of 750-800 is deemed ‘Excellent,’ 700-749 ‘Good,’ and 650-699 ‘Fair.’ Anything below that is subprime i.e. ‘Bad’, ‘Poor’ or ‘Very Poor’. Most banks and non-high-risk lenders prefer a borrower to have a score above 700. A credit score is a foundation for what all banks and lenders go by when granting individual accounts, credits, and loans.
How to Know if You’re a High-Risk Borrower
You may already know that you’re a high-risk borrower, but if you’re not sure, then here are a few pointers.
- A high-risk borrower means you have a poor credit history.
- It’s not about how much debt you have got into, but how well you are at getting out of it or managing repayments. If you have a history of late, slow, or failure to pay back loans, then there is a good chance your credit score is low.
- You have a high credit utilization rate. This is associated with how much debt you owe on your credit card and your credit limit. Reaching the limit regularly can lower your score.
- You often ask for a credit increase or have recently requested a high amount of credit.
- Your credit history is non-existent or limited.
There are ways to improve your credit score, such as building your credit history, making payments reliably, and keeping your credit utilization rate low. There are also a lot of websites online that can give you your credit score if you are still not sure of it or want to double-check.
Types of Loans for Those With Bad Credit
It can be challenging for those with bad credit to obtain a loan. Loan applications can be a bit daunting, especially if you require extra help. However, don’t worry. There are still a few options for those struggling to obtain a regular, low-risk loan.
- An unsecured personal loan. This type of loan is the same as a high-risk personal loan. This is a collateral-free way of borrowing cash. It is solely based on the creditworthiness of the borrower. Always make sure you’re careful when applying for these as fraudsters use this technique to scam people.
- Home Equity Loan (HEL). This is less focused on your financial history and more based on the value of your home. With your home as collateral, the more value in your house, the more money you can borrow. A HEL is a better option when you want to borrow a large amount and want some time to pay it back. Typically, borrowers have up to 30 years to repay it back.
- A loan with a co-signer. This is where you take out a loan with someone else who takes legal responsibility for the repayment of the loan. They will be held accountable if the debtor cannot or does not repay back what is owed.
What Do Lenders Consider?
Although extremely high-risk loans are more accessible than secured lending options, it doesn’t mean that everyone can get one. Lenders will still undertake a few routine checks before deciding whether or not to let someone borrow money. These terms are similar to what you would expect with any other kind of loan.
The amount someone wishes to borrow depends on their income, so a lender will look at a person’s income and pay. Proof of income will need to be provided, which can include documents like paycheck stubs and tax returns.
Repayment history will also be considered. Not just your credit score, but the history of when payments have been due and when they have been paid. The sooner a required payment is repaid, the better.
Whether a warning has been made against you is something lenders will want to know. This could signify that you have been involved in fraudulent behavior. Lenders who are part of Cifas, a fraud prevention organization, can see if your name has ever been used by someone else in the act of fraud.
What Is a High-Risk Loan Good for?
Everyone’s situation is different when it comes down to finances. The strategies that work for one person may not work for another. Whilst a high-risk loan isn’t for everybody, it does work for some.
These types of loans can be useful for paying off debts, especially debts with a repayment deadline that’s coming up quick. There is also an opportunity to build up your credit rating. The immense amount of interest on these types of loans is not always ideal. However, you broaden your options with a higher credit score.
This will only work if you ensure you are timely with repayments, maintain low debt levels, and watch your credit. It’s one way to not only rebuild your credit score and history but to help discipline yourself. If you have previously proven unable to manage payments well, it may be time to develop better habits.
But…
These loans aren’t ideal for paying off credit card debts. Lenders tend to reject these kinds of loans due to a combination of low credit score and a person’s debt outweighing their income. The amount of interest that accumulates can end up being much more than the original credit card debt intended to repay.
Other Options
A high-risk loan may not be for you. Alternatively, your application may not get accepted. Either way, there are other options, especially for using a loan to pay off other debts and credit cards.
Negotiate! Or at least try. You can always send a debt settlement proposal letter to your card issuers, bank, or other relevant creditors. A debt settlement letter states clearly the plan you desire in order to pay back what you owe. This includes a clear outline of timings, amounts, and deadlines for when you plan to have paid back the debt.
You could also undergo a debt management plan. This is set up between the person in debt and the company to whom they are indebted. It allows for a payment system that is suitable for the individual.
To Summarize…
Before making any rash decisions, do your research first. Make sure you know what you’re doing and always be wary of strange companies offering you cash. You can always think about speaking to a financial adviser, too, to learn about whether high-risk personal loans are for you.