If you have bad credit or no credit, getting a loan may be a challenge, let alone a loan with a manageable interest rate. Here are five ways to overcome those challenges!
If you've had the wind knocked out of your credit scores due to financial problems, or because you’re struggling to build credit for the first time, it can be challenging to get a loan. It’s critical to understand the factors that affect your credit and how to build it. You might be surprised to learn that you have more options than you think. I’ll give you five ways to find a loan, even with bad credit.
Having bad credit or no credit is a major stumbling block to getting a traditional loan.
Having bad credit or no credit is a major stumbling block to getting a traditional loan. Lenders view you as a high-risk customer who might not repay them. It’s just a fact that until you raise your credit scores, you won’t fit standard lending guidelines that traditional big banks have to follow.
Factors that affect your credit scores
A common credit misconception is that you only have one credit score. Although FICO is probably the most well-known type of score, there are hundreds of different credit scoring models used by mortgage lenders, credit card issuers, insurers, and merchants. There are even multiple types and versions of FICO scores.
Credit scoring models use algorithms to crunch the data in your credit reports, which are maintained by several nationwide credit bureaus, including Equifax, Experian, and TransUnion. Here are ranges for some popular credit scores:
- FICO Auto Score: 250 to 900
- FICO Mortgage Score: 300 to 850
- TransUnion: 300 to 850
- VantageScore: 501 to 990
In addition to assigning different score ranges, credit scoring models emphasize different factors. For instance, having a missed payment on an auto loan might be weighted more heavily when factored into an auto-scoring model.
The exact formulas of credit scoring models are proprietary. However, FICO says they use the following factors and weights as a baseline for their credit scores.
- Payment history (35%). A record of late payments, accounts in collections, and bankruptcies. This is the top-ranking factor.
Takeaway: Making payments on time is a critical factor for maintaining high credit scores.
- Amounts owed (30%). Your debt compared to your available credit, which is known as credit utilization.
Takeaway: Using a smaller percentage of available credit you have on credit cards and lines of credit boosts your credit scores.
- Age of credit history (15%). How long you've had credit accounts open.
Takeaway: Having older accounts improves your credit scores.
- New credit inquiries (10%). Applications for new credit accounts can temporarily lower your score.
Takeaway: Applying for credit cards, retail store cards, and loans only when you genuinely need them improves your credit scores.
- Mix of credit types (10%). The variety of credit accounts in your name, such as credit cards, auto loans, and mortgages.
Takeaway: Having a mix of credit types helps improve your credit scores.
Due to ongoing changes in these factors, your credit scores fluctuate a few points from month to month. However, an unexpected drop of 20 points or more may indicate a problem that you should investigate right away.
How to check your credit reports for bad credit
Keeping tabs on your credit reports is easy and a smart way to protect your credit and recognize the signs of identity theft. You can view or download your reports every 12 months at the official reporting site, AnnualCreditReport.com.
When you review your credit reports, look for errors and evidence of fraud that may be dragging down your scores without you knowing it.
However, you can get both your credit reports and one or more credit scores as often as you like by signing up at Credit Karma or Credit Sesame. These credit sites give you free credit access, alerts, and helpful information to raise your scores.
When you review your credit reports, look for errors and evidence of fraud that may be dragging down your scores without you knowing it. Problems may include accounts you didn’t open, inaccurate late payments, account balances, or available credit limits.
If you spot any errors, file an online dispute with each of the credit bureaus using their websites. Then contact the creditor that reported the error and ask them to correct the data. Keep checking your credit reports to make sure the problem gets resolved, and your scores rise.
No credit is the same as bad credit
Many people mistakenly believe that if you have no debt, you must have good credit. That’s not true. Having no credit is the same as having bad credit. To have good credit, you must have credit accounts and use them responsibly.
Without a credit score, lenders and merchants have no way of evaluating how likely you are to repay your bills and will probably deny you credit.
If you have a “thin” credit history, you don’t have enough data in your file even to generate a credit score. Without a credit score, lenders and merchants have no way of evaluating how likely you are to repay your bills and will probably deny you credit.
How to get a loan with bad credit
If you’ve been turned down for a loan or don’t want to get stuck paying high, subprime interest rates, here are five alternatives to consider:
1. Get a home equity line of credit
If you’re a homeowner with enough equity in your property, you may be eligible for a low-interest, tax-deductible line of credit to spend any way you like.
Of course, tapping your home equity puts your property in jeopardy if you can’t repay the debt. But if you have a reliable source of income and are disciplined about paying down an equity line, it’s an inexpensive option, regardless of your credit score.
2. Try a credit union
Credit unions are nonprofit organizations known for offering high levels of customer service and low fees. They’re similar to banks but are owned by their members, who typically have something in common, such as living in the same county or working in the same industry.
Compare loans from several institutions so you know you’re getting the lowest interest rate possible before you sign the final paperwork.
3. Use a lending platform
Online platforms that use innovative criteria and technology may be a great alternative to traditional lenders. For instance, peer to peer (P2P) lenders, such as Lending Club, allow you to borrow directly from an individual instead of from an institution. Borrowers post a loan listing that includes the amount they want and why they want it. Investors review loan listings and choose the ones that meet their criteria.
Peer to peer lenders screen all applicants and check your credit, which becomes part of your loan listing. While your credit score is a factor, an individual investor may be more empathetic to your situation than a traditional bank.
4. Take a loan from family or friends
If an online peer won’t lend to you, perhaps you have family or friends who will. Treat a loan from those you know just like a business transaction.
To avoid misunderstandings, create a written agreement with the interest rate, payment terms, any collateral you put up for the loan. Don’t forget to clarify what happens if you fail to repay the debt. You can get promissory note templates from sites such as Rocket Lawyer or LegalZoom.
A family loan must benefit everyone involved and should be a last resort. You don’t want to risk letting a close relationship go sour over a bad debt.
If you’re borrowing money to buy a home, the loan must be secured properly to take advantage of the mortgage interest deduction. To properly register and manage a home loan with a relative, check out NationalFamilyMortgage.com.
The bottom line is that a family loan must benefit everyone involved and should be a last resort. You don’t want to risk letting a close relationship go sour over a bad debt.
5. Find a co-signer
If you don’t have a friend or family member who’s willing to give you a loan, perhaps one with good credit would be willing to co-sign a loan with you. Just remember that if you don’t repay the debt, the creditor will look to your co-signer for full payment.
Also, the payment history for a co-signed loan gets recorded on both of your credit reports. That could be devastating for your co-signer if you don’t hold up your end of the bargain and make late payments or default.
If you exhaust these options and still can’t get a loan, stay focused on improving your credit scores by correcting any errors on our credit reports, paying bills on time, and never maxing out credit cards.