Bad credit loans have a bad reputation. Obviously, a big part of that is deserved. But I’m going to take the contrary opinion here, and say that bad credit loans have a legitimate purpose. Or at least they can, if they’re handled the right way.
Heresy, you say? Maybe. But I’ve had a lot of personal experience with this type of lending. Part of it is due to my long history in the mortgage business, where I saw a lot of these loans, and even did a few myself. Part is also based on my son’s recent experience with a bad credit car loan.
I don’t know if this topic is even on your radar screen, but I’m going to attempt to describe these loans in a way that might cause you to rethink your opinion of them. That’s not to say that I’m advocating using them liberally, but rather that there is a time and place for them. If used intelligently – and sparingly – they can be of some advantage.
Why Bad Credit Loans Have a Bad Reputation
The most obvious issue here is high interest rates. For example, while you might be able to get a car loan for 2% or 3% with good credit, you might pay over 20% with a weak credit profile.
That’s not the worst of it. In addition to the high interest rate, bad credit loan lenders like to extend loan terms. For example, while a new car loan might run for four or five years, bad credit car loans are often extended out to six or even seven years. The longer-term locks the borrower in for more time, resulting in the payment of much more interest.
The evidence is also substantial that default rates are higher on these loans. That makes abundant sense, since the combination of high interest and extended terms eventually weakens the borrower until she reaches a point where she can no longer continue making the payments.
The Subprime Borrower
Back in 2000 I was working for a large national mortgage lender as their subprime loan officer. It was my job to place borrowers in a loan if they were unable to get a standard “A” grade mortgage. It was an interesting assignment to say the least, and while I had moral reservations about it, it set up some better things for me later on. Even after I left that company – after just one year – I continued doing the occasional subprime mortgage for the remainder of my mortgage career.
That experience taught me a lot. Not just about subprime mortgages, but also about the people who take them.
I learned that there aren’t just subprime loans, but there are also subprime borrowers. We might even refer to them as subprime people.
Does that sound harsh? Let me explain.
When I started the job, I expected to work with borrowers who had impaired credit, the type who maybe had a run of bad luck, that resulted in a bout of bad credit, after a long history of good credit standing. I was thinking that there were people out there who had experienced job losses, business failures, medical catastrophes and other temporary setbacks.
But I was as wrong about that assumption as I had ever been about anything. That type of borrower was the exception.
What was far more common were people who had 10, 15 or even 20 pages of bad credit on their credit reports. That would include dozens of individual credit experiences, with most or all having delinquencies or worse. Typical in the credit mix were collections. Bills that had gone from late, to seriously late, and eventually to nonpayment status.
It wasn’t unusual to see such a credit report with anywhere from a half a dozen to a dozen or more unpaid collection accounts. Some of those eventually morphed into court judgments. But it never mattered, because such people never pay their debts.
That’s what I mean by subprime people.
There are no small number of people like that. The irony is that they always come back to get more credit. And the reason that they do is because someone somewhere will give it to them.
And most likely, they’ll stiff the next lender in the very same way that they did all the others before them. It’s all about getting something for nothing, even if it comes through the back door.
I came to realize that this was a game being played between subprime borrowers and subprime lenders. It’s probably a happy marriage – in a perverted sort of way. Both the lenders and the borrowers deserve each other, making it a built-in market for bad credit lenders. That’s largely why I exited that subprime loan officer job after just one year. You can only be around that stuff for so long before it gets to you in unexpected ways.
But let’s move on…
How Bad Credit Loans Can Help You
Let me stress something important from the outset. I’m not referring to short-term bad credit loans, such as payday loans, title loans, or pawn shop loans. Those are very short-term loans with astronomical interest rates, that don’t report on-time payments to the credit bureaus. They also have all kinds of provisions in the event that you don’t pay, stopping just short of seizing your firstborn child. You don’t need a loan like that, and taking it can’t help you without putting you in an even deeper hole.
What I’m really talking about are more along the lines of subprime car loans or secured credit card arrangements. Those can help you in several different ways:
- To build credit – if you have no credit at all, a bad credit loan could be your foot in the door.
- To rebuild credit – if you’ve had a run of bad credit, and need to rebuild, getting a bad credit loan may be the best way to do that – particularly if you can’t get credit anywhere else.
- Because there’s no other choice – if you’re in a situation where you absolutely need a car, and you don’t have the cash, a bad credit car loan may be the only alternative.
Even under these circumstances, bad credit loans should be used sparingly and conservatively.
Making Bad Credit Loans Work
If there are times when taking bad credit loans makes sense, what do you need to do to make them work?
- Lower your sights – never take a loan that you can’t repay; that goes for good credit loans too (I saw a fair number of people default on “A” loans in my long mortgage career).
- Borrow less than you “need” – life is full of compromises, and this is an excellent time to do just that.
- One bad credit loan is more than enough – you don’t need several.
- Make your payments on time every month – get a second job if you need it to make that happen.
- Apply for good credit loans – for very small balances – every few months; that will provide you with more opportunities to improve your credit score.
- Carefully read the fine print on the loan, being on the lookout for “gotcha provisions”, like prepayment penalties and balloon payments.
- Think of your bad credit loan experience as an entirely temporary one.
- Pay the loan off as soon as possible – a paid loan is one of the best credit references you can have.
Here’s the thing – while there may be occasions in your life when you will need a bad credit loan, you should never turn bad credit loans into a lifestyle. I saw that happen with dozens, maybe hundreds of people during my subprime mortgage run. I can tell you that it never leads to a good place.
You should be just passing through with a bad credit loan, and on your way to better things. But that will only happen if you make it happen. If you do, then bad credit loans can serve a very useful purpose. If you can use them to build or rebuild your credit, or get through a rough patch, then they can bring you to a better place. But if you become too reliant on them, you’ll be stuck on the bad credit treadmill – the one few people ever get off of.
My Son’s Experience With a Bad Credit Car Loan
When my son was 21 he and a certain deer had a date with destiny. He collided with it on a freeway turn ramp, and his car was totaled by the insurance company. Time to buy a new car. Problem: he had no credit history. His car was a “beater”, and owned free and clear, so no credit rating there. My wife had set him up with a credit builder loan through her credit union, but it was too new to have a major impact on his credit.
But he needed a better car for work purposes. Buying another beater wouldn’t work. He had a 50 mile round-trip commute each day. Not only did he need a new car, but he needed one quickly. He settled on a new used car, that was four years old.
In order to buy it, he needed a $10,000 loan. With no credit, he was forced to take a bad credit car loan. The interest rate was out in the stratosphere – nearly 23%. It was also set up as a 72 month loan, locking him in for a full six years.
Times being what they were, he took the loan and bought the car. It wasn’t a comfortable situation, but for 18 months he made the payments on time. He also developed several other small credit lines along the way – which he was able to get, largely because of the car loan – and also paid those on time.
Last week he went to our credit union and applied for a new car loan. He was approved for a $40,000 loan at 3.99%, with his choice on the loan term.
I’m proud to say that my son is an excellent example of someone who used a bad credit loan to his advantage. He took it on a temporary basis, made sure that it was small enough that he could afford the monthly payment, faithfully made the payments on time, and otherwise built up his credit. As a result, he’ll be able to either refinance the loan 4 ½ years early, or to buy a different car entirely.
Based on my mortgage experience, I suspect that’s not the way bad credit loans end for most people. But it’s an example of what can be done if bad credit loans are used intelligently.
Are Bad Credit Loans Helping or Hurting Credit-impaired Consumers?
This is an ongoing debate. On the one hand, bad credit loans are usually the only type of financing that people with bad credit can get. If they can’t get these loans, then they’re cut off from credit completely. And you can’t take people with bad credit and put them in good credit loans. There’s a very high likelihood that they’ll default on those loans as well, and drive up the cost of borrowing for everyone else.
But on the other hand, there’s the argument that bad credit loans keep people with impaired credit situations in that ditch forever. Given the high interest rates and eternal loan terms that they impose, that’s not an entirely invalid argument.
But based on my son’s experience, and that of a very few other people, bad credit loans can be a useful tool if used the right way. That will never happen with subprime people, because they have little motivation in that direction. But if you’re disciplined to pay your obligations on time, and you just need some extra help in a compromised situation, bad credit loans can get the job done.
Philosophically, I’m opposed to bad credit loans. But if you live long enough, you’ll reverse course on a lot of things that you never thought you would. That’s been my experience.
Have you ever taken a bad credit loan? If you have, how did it work out? Do you agree that they can be valuable in the right hands?