High-risk loans are generally for borrowers who have a limited or bad credit history. Since lenders view these types of borrowers as more of a risk, high-risk loans often come with higher interest rates than traditional loans.
Because of these high costs, it’s important to understand how these loans work before getting one.
- What is a high-risk loan?
- Types of high-risk loans
- Who’s considered a high-risk borrower?
- Is a high-risk loan right for you?
- Why should you avoid high-risk loans?
- What are some alternatives to high-risk loans?
What is a high-risk loan?
A high-risk loan is a type of loan that’s easier to qualify for. However, many high-risk loans are considered a predatory form of lending.
High-risk lenders approve borrowers with low credit scores and poor credit histories. While this may sound like a good thing, high-risk loans typically have incredibly high interest rates and expensive fees to mitigate the risk for the lender. You’ll likely also have a short repayment term for the loan, which can make it difficult to pay off.
Many high-risk loans are unsecured (no collateral required). But some loans may require you to put up collateral, such as your car’s title. In this situation, the loan becomes an even higher risk for you — if you default on your loan, the lender can recoup its losses by seizing your collateral.
Types of high-risk loans
High-risk loans come in many forms, including:
Payday loans
A payday loan is a short-term loan that allows you to borrow a small amount of money (usually $500 or less) that you must repay when your next payday arrives. This means your repayment term is typically only two weeks. In addition to short repayment terms, payday lenders charge sky-high annual percentage rates (APRs), which is your interest rate plus any fees. You may have an APR of nearly 400%, thanks to the costly fees associated with borrowing the money.
Lenders often require borrowers to write a postdated check for the loan balance (and any fees), or allow the lender to debit the funds from a bank account. If you can’t pay back the loan in time, you may be able to extend the due date, but you typically must pay an additional fee each time you do so.
Car title loans
An auto title loan uses your vehicle as collateral to secure loan funding — typically a percentage of your car’s value. You provide the lender with the title to your vehicle, and if you can’t repay your loan, you lose your car.
As with payday loans, APRs are high — they can go up to 300%. They’re also short-term loans, with repayment terms ranging from 15 to 30 days. Car title loans often have costly fees for things like processing and loan origination.
Bad credit personal loans
You may be able to qualify for a traditional personal loan that’s specifically geared toward borrowers with bad credit. With a personal loan, you receive a lump sum of money upfront and repay the loan in fixed monthly installments, with interest. You may be able to get a debt consolidation loan to pay off multiple existing debts.
However, bad credit personal loans usually come with high interest rates. You may also have to pay an origination fee for your loan application to be processed, which can be as high as 10% of your loan amount.
Who’s considered a high-risk borrower?
In most cases, a high-risk borrower is someone whom lenders view as likely to default on a loan. Lenders look at several factors to determine if you’re a high-risk borrower, including:
- Low credit score (a FICO credit score between 300 and 579)
- Many late payments in your credit history
- High outstanding balances on credit cards
- Limited credit history
- Several credit inquiries (loan or credit card applications) within a short time frame
Is a high-risk loan right for you?
In some cases, a high-risk may be the right choice. But remember to proceed with caution when it comes to payday loans and car title loans.
It may make sense to get a high-risk loan if:
- You don’t have other options. If you’re a high-risk borrower, your options are much more limited than those of someone with strong credit. Sometimes, these types of loans are the only ones available to you. In an emergency, you may choose to turn to one.
- You know you’ll be able to repay the loan. If you’re confident that you can repay your loan as agreed, this may be a worthwhile route.
- The loan has a lower interest rate than your current debts. If you qualify for a loan with a lower interest rate than what you pay on your credit cards or other accounts, it may make sense to consolidate your debt with a personal loan.
- You want to avoid borrowing from your retirement accounts. A high-risk loan may be a better choice than a 401(k) loan if it means it won’t jeopardize your financial future. Taking a loan from your 401(k) can also be expensive — if you can’t repay it and you’re under the age of 59 ½, you must pay a 10% penalty on top of taxes on the amount.
Why should you avoid high-risk loans?
High-risk loans aren’t the best financial products out there, and it’s best to avoid them if you can.
Here are some reasons to steer clear of high-risk loans:
- You pay extremely high interest rates. Most high-risk loans have interest rates that are much higher than those for traditional loans, so you pay more to borrow money.
- Your loan has expensive fees. Many high-risk loans charge origination or other pricey fees when you borrow money. With multiple fees on a single loan, the charges can quickly add up.
- You could get trapped in a cycle of debt. A loan with high interest rates, expensive fees, and a very short repayment term could put you in a position where you’re struggling to repay it. If you miss payments or extend due dates, the fees can continue to pile up and make it even more difficult to get out of debt.
- Lenders may offer very small loan amounts. Payday loans, for example, only allow you to borrow up to $500, which may not be useful if you need more money.
What are some alternatives to high-risk loans?
The good news is there are other ways to get access to cash or get some relief for your financial situation. Some alternatives to high-risk loans include:
- Credit counseling: These are typically nonprofit organizations with certified counselors who help you manage your finances, including debt and budgeting. A credit counselor will discuss your situation with you and create a personalized plan to improve your financial situation. You can find nonprofit credit counseling agencies through the National Foundation for Credit Counseling (NFCC).
- Debt management plan: A credit counselor can also create a debt management plan. This is an agreement between you and your creditors, and it may help lower your monthly payments, interest rates, and fees. You simply make one monthly payment to the credit counseling agency, and the agency sends your funds to your creditors. This can make paying down your debt more affordable.
Be sure to look for nonprofit agencies through the NFCC — there are scammers who claim they’ll negotiate with your creditors for a hefty fee but don’t actually help you. - Credit card: Credit cards can have high APRs. However, these rates may be lower than those for high-risk loans. Plus, you may be able to borrow a larger sum of money, depending on your credit limit.
