In this day and age, loans have undoubtedly become an integral part of most of our lives. Whether it's for buying your first home, a car, or even securing an additional bit of funding for your business.
Have you ever heard of bad credit-secured loans? These are a type of loan given by the bank in which the borrower has to pledge some form of collateral, like a property or other valuable asset, to the lenders.
The concept is that by giving the banks some sort of reassurance with the collateral you provided, they're more comfortable ignoring your poor credit history as they have something of yours to fall back on should something happen.
Throughout this article, we'll delve into the world of secured loans for bad credit and cover all you'll need to know before ultimately signing up for one.
How do they differ from unsecured loans?
Before going into the benefits and how to apply for a bad credit-secured loan, it's crucial we distinguish these similar, but unique, loans so you can make better borrowing decisions and steer clear of any unnecessary risks you might encounter.
Both financial tools are effective, but it's still worth knowing what sets them apart:
What are secured loans?
As briefly touched on at the start of the article, secured loans are a type of personal loan that's backed by some kind of collateral as a form of security for the lender.
Generally speaking, this means that if you were to somehow default on the loan you've been given, the lender then has every right to seize the collateral you provided in order to recover their money back.
Because secured loans are backed by collateral, it typically means they're viewed as less of a risky deal for the lenders. This means that unlike some of the other loan types, you'll likely be offered the opportunity to take out larger amounts of money.
What are unsecured loans?
Unsecured loans are the most basic of their kind, with lenders relying on your creditworthiness rather than collateral when making their decision to lend you the money or not.
This involves them checking out your credit score, income, and history of employment in order to see how likely you'll be to pay the loan back on time, if at all.
It is worth noting however that if you somehow default on the loan, your credit score can take a big hit and you may be charged a fee.
Which kind of loan is right for you?
It's all down to whatever your personal circumstances are, but the right loan for you can depend on a range of different factors. This includes things like your credit score, the purpose of the loan, and how much you need.
Let's say you've somehow managed to build up a poor credit history over the years but are by no means poor, you may have a valuable asset or two that you feel comfortable putting up for collateral.
In these circumstances, you'd probably benefit a lot more from a secured loan than an unsecured loan, as you'd get access to all the perks of the former option without having to demonstrate your creditworthiness.
However, if you've been a bit less fortunate with valuable assets in your possession, you may feel more comfortable looking at an unsecured loan, though you'll struggle to get one of these loans with bad credit history.
What is bad credit?
We've touched on the phrase “bad credit” quite a lot in the previous sections of this article, but what exactly is it, and what would you need to do to end up with a bad credit score?
Defining bad credit
A credit score, often referred to as a FICO score, is a number representing how reliable you are based on your financial behaviour in the past.
These scores typically range from around 300 to 850, with higher scores indicating better creditworthiness. Generally speaking, if you've got “bad credit”, it usually means your score has fallen below somewhere around the 600 level, which suggests to banks that there's been a bit of a track record when it comes to missed payments, high balances, or other negative credit events.
Impact of bad credit
It goes without saying that having a high credit score can make your financial life significantly easier, meaning banks streamline your application process and are generally stumbling over themselves to be the first to offer you a loan/financial commitment.
Conversely, it would follow that a poor credit score suggests you're a high-risk borrower. As a result, you'll find that many lenders may either deny your loan application or charge you higher interest rates and fees to offset the perceived risk on their end.
Factors that contribute towards bad credit
Let's take a closer look at what exactly would cause banks to determine you've got a bad credit rating.
Late payments
This is the joint biggest factor banks consider when working out your credit score. Even if you're off by a few days, late payments can have major impacts on how likely you'll be to secure loans in the future.
High balances
When you have quite a high balance in your credit card, it can increase something known as “credit utilisation ratio”. This refers to the percentage of available credit that you're currently using, and having a high ratio can negatively impact your credit score too.
Too many credit applications
This one is understandable to the average person, as desperation can cause anyone to think erratically and panic, and apply to a range of different credit card products within a short period of time. However, this is unfortunately a big no-no as far as the banks are concerned.
Applying for multiple options at once, despite showing that you're clearly proactive in improving your credit rating, can suggest to lenders that you'll do anything for some credit, which ultimately damages your overall rating.
Defaults
Defaulting on a loan, which means failing to make payments as agreed, can have a severe impact on your credit score.
Consequences of bad credit
At this point, we've made it quite clear that it's unfavourable to have a bad credit rating, but let's clearly define a few of the consequences anyway, just for added clarity:
Higher interest rates
In order to compensate for the risk they'll be taking on by lending someone with bad credit money, oftentimes you'll have to pay higher interest rates and fees. This is generally so it's still a worthwhile deal for the banks, as they've got no guarantee you'll pay the loan back in time.
Difficulty getting approved for loans
As mentioned earlier, you're likely going to face difficulty when looking to get approved for things like loans, credit cards, and various other finance-related products.
Trouble renting or buying a home
Aside from just the banks, landlords, and mortgage lenders will often check out your credit score when evaluating rental or mortgage applications.
Not all of them do this, but in general, a poor credit score can complicate the procedure even more when it comes to renting or buying a home.
Applying for a secured loan
Now that we've come to terms with the basics of bad credit-secured loans, it's time to understand the application process. First things first, it's vital to research different lenders so you can accurately compare them and their offers. This will also give you an idea of who's offering the best rates, terms, and conditions that fit your needs.
After you've found a lender that best represents your requirements, your next step is to fill in an application form.
This is normally a pretty basic document, in which you'll have to provide a bit of personal information such as your income and the collateral you're using to secure the loan.
Time for the last step! You've already submitted your application, so what comes next? When the lenders have received all your documents, they'll review everything to determine whether or not to approve your loan. If you're fortunate enough to pass this stage, your lender will give you a loan agreement document that'll outline the terms and conditions of the deal.
This includes stuff like interest rates, terms for monthly repayments, and other miscellaneous fees and charges that could be attached to it. Next, all that's left for you to do is review the document and give it your seal of approval, and the lender will disburse the loan amount to you!
Documentation for a secured loan
As mentioned, you'll need to have some crucial personal information at hand while you're in the application process. The specific documentation itself will typically vary depending on who you're lending the money to, but generally speaking, you will need to provide:
- Proof of income: payslips, bank statements, or tax returns
- Proof of identity: identity documents like a passport or driving licence
- Proof of collateral: property deeds or ownership certificates
If you're looking to expedite the loan application process, ensuring all the documents you're providing are accurate and up-to-date can be a huge time saver for all parties involved in the agreement.
The importance of comparing lenders
Lenders aren't made equally, and you'll find that the rates and offers will always vary depending on who you're borrowing from.
As a word of advice, it's always crucial to look beyond the interest rate to other factors associated with the loan. This extends to things like fees, charges, terms and conditions, or any other fine print that may come back to bite you later if you're not careful.
This is generally a good practice for any documents you'll sign throughout your life, but specifically for the context of securing a loan, you'll be able to guarantee that whatever terms you'll receive will be both affordable and conducive to your current financial requirements.
Tips for managing secured loans
To end things off, let's go over a few simple hacks you can use to ensure you're getting the most out of your loan.
Negotiate
If you are struggling to make your loan payments, get in touch with your lender as soon as possible. Many lenders are willing to work with you if you're experiencing financial difficulties, and you might be able to negotiate better terms like a longer repayment period.
Seek help
We recommend receiving free financial guidance from a charity or debt organisation such as StepChange
Consider refinancing
Lastly, if all else fails, it might be worth looking into refinancing options. This is a fairly easy process, which essentially boils down to taking out a new loan, often with better terms, to pay off your current loan.
This is the main premise behind balance transfers, in which a borrower migrates from their high-interest credit card to another so they can take advantage of their 0% interest periods.
While this can be a massive help in lowering monthly repayments and keeping up with various loan obligations, don't forget there are often a bunch of sneaky fees involved, such as a 3-5% fee on the total amount you transfer.
