High-Risk Loans

Main Advantages and Disadvantages of High-Risk Loans – Our Guide

If you want to make a large purchase, such as a house or a car, chances are that you’ll seek a loan to cover the costs. If you have a few blemishes in your credit history, though, finding a lender to give you a loan can be challenging.

The good news is that even if you made a few credit mistakes in the past, there is still hope to secure a loan and attain your dream purchase. You would be considered a high-risk borrower and may therefore be eligible for high-risk personal loans.

Keep reading to learn more about high-risk personal loans, including whether or not you might be eligible for this type of loan and how you can secure one to finance your dreams!

What are High-Risk Loans?

It’s important to understand what a high-risk loan entails before beginning the process of pursuing one.

In short, a high-risk loan is a loan offered to those with a less than stellar credit history. High-risk loans are typically subprime loans, meaning that they are loans offered at a rate above prime to borrowers with low credit ratings. You may also see them called bad credit loans.

Typically, what indicates to lenders that you’re a high-risk borrower is a low credit score, because a low credit score suggests that:

  • You have a history of paying your bills late
  • You keep your credit card balance high and close to your limit
  • You have taken out a lot of credit or made requests for multiple loans in the past

One thing to know about a high-risk loan is that it’s an unsecured loan, which is where the risk lies for high-risk lenders. Unlike a secured loan, such as a mortgage which requires you to put your house up as collateral, high-risk loans don’t require you to put up any of your possessions if you fail to pay the loan back. So, the lender has no legal claim to your assets in the event of default and depends solely on your financial capacity to and trust that you will pay the loan back.

With so much risk for borrowers with a history of bad credit habits, you might be asking yourself: what’s in it for high-risk lenders? The answer is interest.

The way that a lender justifies giving a high-risk borrower a loan is by charging a high interest rate. The idea is that if you do end up not repaying the loan, the interest can cover some, if not all, of the lender’s loss. What’s more, borrowers may feel more incentivized to pay their loans back quickly to prevent high interest rates from engulfing their pockets.

Why Take Out a High-Risk Loans

Why Take Out a High-Risk Loan?

With such high interest rates, high-risk loans may seem like an unattractive option, but there are many situations where the borrower might benefit from a high-risk loan if they can pay back the full amount promptly.

Pay Off Your Other Debt

If you have multiple loans or credit cards with high interest, it may make sense to consolidate your debts.

Debt consolidation involves obtaining a new loan to pay off a series of smaller loans. You essentially use this new, larger loan to pay off several smaller ones, combining your debt into one and requiring you to make only one monthly payment.

There are several reasons to consolidate your debt:

  • Simplifying your debt repayment. You no longer have to remember several due dates, meaning that you let fewer payments slip through the cracks.
  • Reducing the interest rate. If you have high-interest debt, such as credit card debt, taking out another loan with even a slightly lower interest rate to pay off this debt may end up saving you time and money in the long run.
  • Paying off your debt faster. If you end up with a lower interest rate than you had while keeping the same payment amount and schedule, chances are that you’ll end up paying your debt off a lot faster.

It’s important to note that a high-risk loan might not be the best way to consolidate your debt. The interest rate of a high-risk loan may end up being higher than the interest rates for your other loans, which doesn’t benefit you in the long run.

Increase Credit Score

One of the best reasons to say yes to a high-risk loan is to start rebuilding your credit.

Taking out another loan to increase your credit score may sound counterintuitive, and your score may indeed take an initial hit once approved for your high-interest loan. However, a new loan allows you to show that you’re capable of paying down your debt on time.

If you continue to pay off your high-risk loan on time every month, you will demonstrate consistency and see your credit score increase. Better yet, try to pay more than the minimum amount to pay down your loan quicker and prove that your past money mistakes don’t define you today.

Now that you know how high-risk loans may benefit you, you need to determine if you’re eligible for one.

What You Need for High-Risk Loans

Applying for a high-risk loan is as simple as applying for a credit card or any other type of loan. You can do it by contacting any conventional lender, such as your local bank or credit union. In some instances, you can even complete an online application. You need your personal information and some additional documents.

However, considering the stakes of high-risk loans, lenders sometimes require many steps and several components to be included in your application. If you have a bad credit score, the application process can be more complicated.

Here’s what you typically need to qualify for a high-risk loan.

Credit Score

The most important aspect of determining your eligibility for a high-risk loan is your credit score.

Sure, lenders already assume that you have a low credit score if you’re applying for a high-risk loan, but just like any other loan, exactly how low that score is determines how much you can qualify for, if at all.

Some high-risk lenders do have cut-off points when it comes to credit scores. For example, if your credit score is below 500, you generally have a lot more trouble securing a loan, even a high-risk loan.

Even if you do qualify for a high-risk loan with a credit score below 500, the loan may most likely be a small amount with an extremely high-interest rate that might not even be worth it in the long run.

Be sure to look at your credit score and review your credit report before applying for a high-risk loan to understand where you stand. Any high-risk lender will do their own credit check before approving the loan, but you should still gather your own information to determine if you have poor credit.

Proof of Income

No matter what type of loan you take out, lenders want to know that you can pay back the loan and have evidence of how you’ll be paying it back, which is why you need to provide proof of income.

Proof of income is a key part of your high-risk personal loan application. It proves to lenders that you have an adequate income to pay back the installment loan consistently and on time. Whether you’re employed full-time with a stable income or receive some other type of payments (i.e., pension), you need to prove that you have money coming in.

Along with proving that you have sufficient funds to cover paying back the loan, proof of income also gives lenders an idea of your debt-to-income ratio, which is the percentage of your income that will go towards paying down your debt. You can calculate your debt-to-income ratio by adding up how much you pay in monthly debts and dividing it by your income before taxes or gross monthly income. What you’re left with is a percentage, your debt-to-income ratio.

The ideal debt-to-income ratio for lenders typically hovers around 30%. However, for high-risk borrowers who may typically have a higher debt to income ratio, a lender may offer a little bit of leeway in terms of the acceptable percentage.

If your income alone isn’t enough to get you approved for a high-risk loan, consider asking someone to be your cosigner. In the eyes of the lender, a cosigner is someone who would approve all risks if you fail to pay your loan, meaning that they become responsible for your payments. For best results, your cosigner should be someone who has a stable income and a good credit score to compensate for your high-risk profile.

Affordability

Just because you’re approved for a loan doesn’t mean that you can afford to pay it back. These circumstances could be why you ended up in need of a high-risk loan in the first place!

It’s important to determine whether or not you’ll be able to keep up the payments when paying back your high-risk loans. To best prepare, pay special attention to the interest rate you agree to and estimate how much your monthly payments will be.

Speak to an Expert

Since every loan you apply for triggers a hard inquiry into your credit – which can negatively impact your credit – do all of your research before jumping into an application.

Start by looking at your local banks and credit unions to determine where you may find the best rate, then compare rates and find out each institution’s requirements for high-risk loan applications. It’s a good idea to contact them or another financial expert to discuss your options.

When you’re ready to apply, be sure to gather all of the relevant information for your application to make the process go smoother. This information may include:

  • Credit report (although this is usually pulled by the lender, it’s still a good idea to have it on hand).
  • Proof of income (paystubs, W-4 forms, letter of employment).
  • A cosigner, if applicable.

Pros and Cons of High-Risk Loans

Pros and Cons of High-Risk Loans

As mentioned, high-risk loans have their advantages to obtaining funds and improving your credit. The benefits of high-risk loans include:

  • Accessing a loan while carrying a low credit score.
  • Obtaining a personal loan to purchase something now instead of waiting.
  • Consolidating your debt for simpler payments.
  • Increasing your credit score with a new lender willing to give you a chance.

That said, there are still a few drawbacks to pursuing a high-risk loan, such as:

  • Obtaining additional debt.
  • The responsibility of having to pay back the loan on time.
  • Higher interest rates.
  • The potential necessity of a cosigner.

When determining whether a high-risk loan is the best option for you, consider each of these pros and cons to determine if you can keep up with payments or if this type of loan really will benefit you in the long run.

High-Risk Loans – Final Thoughts

High-risk loans can open up opportunities for those who have made financial mistakes in the past and just need a second chance.

Applying for a high-risk personal loan through a traditional lender can be as simple as applying for a credit card, but make sure you can handle a loan with such a high interest rate, especially if you’ve made poor financial decisions in the past and have a less-than-stellar credit rating.

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Jen M.

Jen has been with DCCU since she graduated from UW Madison - a long time ago. As the Content Strategist she helps share all the amazing things DCCU does in our community and spreads the credit union philosophy of People Helping People. When she's not working for the best credit union in south central Wisconsin, she's busy with 4 kids and a feisty little dog at home. She formed her family through adoption and has a deep passion to support foster and adoptive parents and kids. Her favorite place to relax is poolside or in front of the fireplace.