Whether to take out a loan with bad credit depends on what the reward is compared to the cost. You have to take into account the total cost of the loan and the cost of not having it. If the cost of not having the loan is more, then you should probably take the loan and the opposite is also true. Let’s look at several categories of loans and see when it might be a good idea to take a bad credit loan.
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Home Loans – Auto Loans – Installment Loans
Home Loans
Bad credit is generally a score of less than 620. As your score drops below this level, conventional home financing can get difficult.
If you have bad credit, you still have options in the home mortgage market though. You can still get a reasonable loan with scores as low as 500. There are many government loan programs that make home ownership possible if you have bad credit. Here are the ones you may consider.
FHA Loans
With an FHA loan, you can get a home loan with just a 3.5% down payment as long as your score is above 580. You can even get a loan with a score as low as 500 but then you would face a down payment of 10%.
The drawback to the FHA program is the mortgage insurance requirement. Mortgage insurance can raise the price of your monthly mortgage by hundreds of dollars.
While you still might pay higher interest with bad credit, an FHA loan is usually worth taking. It can get you into a home when you otherwise might not be able to.
USDA Loans
If you live in a rural area, you can also get a loan with low credit. The USDA loan will have a higher initial cost than an FHA but the monthly insurance is much less. Everything else being equal, if you qualify for a USDA loan, it will be even cheaper than an FHA loan.
The downside to a USDA loan is that you must be in a rural area but the definition of rural often means that you can be on the outskirts of a major city. If you can deal with a bit of a drive, you can have a USDA loan and still live in an urban area.
VA Loans
The king of all bad credit loans for home purchases. There is no set credit requirement for a VA loan but most lenders will want a 620 credit score. Sure, you can get an FHA with a lower score but you will pay a huge down payment compared to the zero down you can get with a VA loan. If you meet the military requirements needed to get a VA loan, you would be hard pressed to get a better deal.
With a VA loan, you can qualify with bad credit, there is no down payment requirement and unlike the other two loans, there is no mortgage insurance requirement. That alone will save the average borrower hundreds of dollars a month.
Conclusion
In general, if you have bad credit but can qualify for one of the programs above, it is worthwhile to take out the loan. The cost of not having a home is far greater than the cost of the loan.
If you do not qualify for one of the loans above, your next step would be to look at the subprime home lending market. In that case, you would be better off skipping the loan. Subprime home loans will be come with interest as high as 8 to 10 percent and down payments as high as 25%. The cost of the loan far exceeds the cost of not having a home in this case. Avoid sub prime home loans.
Auto Loans
Just like with home loans, things get more difficult as your score drops below 620. There will always be lenders willing to work with you but they may not be worth using.
As your credit score drops, your interest rate will get increasingly higher. Once your score drops below 620 is when the rates really start getting high. Rates start coming in at 18% and higher.
You can lower your interest rate in several ways though.
First, a large down payment. The more that you put down, the less risky the loan becomes. If you pay down an amount equivalent or greater than the vehicle depreciation, a lender knows they could get most of their money back if you default.
Second, you can get a cosigner. If you get a cosigner with a higher credit rating, you can piggyback off of their credit. It can get you a much lower rate. If you default, the lender has someone else that they can pursue to collect their money.
Conclusion
The decision to take out an auto loan with that high of a rate will depend on your need. If you need a car to survive then yes, it probably is beneficial to take out a high interest auto loan. Take out the loan and pay it regularly. In a year, if you make your payments on time, you may be able to refinance the loan at a lower rate.
If you only “want” a new car and have reliable transportation already, you should skip the loan. Take the money that you would have spent on the extra car payment and use it to pay down credit balances. Keep making your other payments on time and wait until your score moves into the fair to good credit category before looking at an auto loan again.
Installment Loans
Installment or personal loans can be used for a variety of reasons. Many people will take them out to consolidate debt or to pay for a home improvement project. If you have great credit, they are usually not a problem but with bad credit, they can be costly.
There is no shortage of lenders ready to make you a bad credit installment loan. Interest rates are high, so despite a higher default rate, they are still profitable for lenders.
To cut down on that interest, you can do several things.
One is to get a shorter term. The longer a loan is, the riskier it is for the lender and the higher the rates will be. All things being equal, a 3 month installment loan would have a lower rate than a 6 month one.
Another way to lower your interest is to look to a secured installment loan. If you have a clear title to your auto or other valuable asset, you can put it up as collateral. This cuts the risk to the lender and should lower your interest.
Conclusion
Like every loan, you need to look at the cost of the loan versus the cost of not having it.
If you are using your installment loan for a home repair that can not be postponed, it might be worth pursuing. Likewise, if you are consolidating credit card debt and can get a lower rate than you are currently paying, it might be a good loan for you.
Any loan with high interest for a non necessity like jewelry, it should probably be skipped unless you are in a strong financial position that allows you to absorb the cost.
