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Debt Consolidation Loans for Bad Credit

If you have a bad credit record and a poor credit score, being approved for a loan with decent terms, or even simply getting a loan in the first place, can be very challenging.

Any option presented to you as a fast and easy solution will most probably be so only on the surface. Bad term loans (loans with a very high interest rate or fees) are made readily available to bad credit borrowers, but you can't use these loans to consolidate your debt, since an essential requirement of a debt consolidation loan is that the terms on the new loan must be better than the ones on your current debt.

An extra effort and knowledge is therefore required in order to get a loan with convenient terms and in a large enough amount to pay off your existing debt. You must also be careful to recognize and avoid the many traps that you will encounter.

As with all loans, bad credit loans are available as secured or unsecured loans. We'll review and analyze what loan options are available to you and what strategies you should undertake in order to obtain a loan that is suited for debt consolidation.

What is considered "Bad Credit"?

First of all, let's define "bad credit" and make sure that your credit score indeed fits into this category. In short, if your score is below 620, then it will probably considered bad. But let's analyze the matter in detail:

There are two companies that provide credit scores: FICO (still used by the vast majority of lenders) and VantageScore (created in 2006 by the three major credit bureaus: Equifax, Experian, and TransUnion). Both the "FICO Score 9" and the "VantageScore 3.0" (the latest version launched in March 2013) have a 300 to 850 range. The higher the score, the better for you and for the lender, as it signals a low risk of default. Therefore, 850 is the highest (or best) possible score, while 300 is the lowest (or worst) possible score. However, there is no specific "cutoff" number which defines what is a "bad" or a "good" score.

Each individual lender (creditor) has its own definition of what constitutes an excellent, good, fair, bad, or subprime score, and will make its lending decision based on its self-defined categories, as well as the level of risk it considers acceptable for any given credit product offered. In addition, other factors other than your credit score are considered, even though a bad credit score is often a sufficient reason for declining a loan.

So there is no "official" bad credit score number. However, based on the commonly accepted rule that to be eligible for a "prime" loan your credit score has to be at least 620, it follows that anything below 620 shall be considered "subprime."

Therefore, as we have outlined in our credit score table, a score below 580 can be generally considered as "very bad credit" (definitely subprime), while a score between 580-619 can be classified as "bad credit" (or "near" prime, indicating you still have bad credit, but it's closer to being sufficient, or "fair").

You should take the above numbers as purely indicative of what a lender might consider as being "bad credit." Neither the companies who provide credit scores (FICO and VantageScore) nor the credit reporting agencies that supply credit reports (Equifax, Experian, and TransUnion) decide which credit scores are "bad" or "good," so it is left to each lender to decide that. Some lenders might consider anything above 600 as being "fair" credit, a score in the 500 to 600 range as being poor, and only one below 500 as really bad. Others might place the limits higher and will considered a score to be acceptable only if it's above 640 (as is the case with Peer to Peer lenders) or even 660.

If you have bad credit but own an asset, consider a secured loan

The first element to understand is that whereas a good credit score is the primary requirement for obtaining an unsecured loan (in addition to a stable income and a low debt-to-income ratio), in order to obtain a secured loan the main criteria considered is the asset you place as collateral, not your credit score. Assess the solidity of your income and your personal risk tolerance, and if a secured loan appears as a solution you feel comfortable with, then it's definitely the first option to look at when you have bad credit.

Home equity loan or mortgage refinancing

With this in mind, if you have bad credit but own a home, it will be easier to obtain a secured loan backed by your home, such as a home equity loan or cash out mortgage refinancing, rather than an unsecured one. These loans usually offer the lowest rate you can get with bad credit, the advantage of being able to deduct this interest on your tax return, and extended repayment terms of the loan (anywhere from 5 to 30 years) if needed to further lower your monthly bills when the decrease in interest costs is not enough.

401k loan or life insurance loan

If you own other assets such as a 401k or a life insurance policy, you could take out a 401k loan or a life insurance loan as a way of consolidating your debt. A 401k loan (or other type of retirement account loan) is particularly suited if you have bad credit, because it doesn't require a credit check.

Car title loans are a bad idea

If you own a car, you might have heard about car title loans. However, these should never be considered as an option for debt consolidation because of the extremely high interest they carry. With triple-digit interest rates, even if you take out a car title loan as a form of short term cash flow relief (as it is intended), at best you will be paying much more money than on your current debt, and at worse you risk being trapped in a cycle of increasing debt and loose your car.

If you don't own a home: unsecured loans for bad credit

If you are not a homeowner, your options are restricted to the unsecured loan category (personal loans and the like). Because an unsecured loan isn't guaranteed by an asset, it only relies on the credit worthiness of borrowers as a guarantee of the loan being paid back. Your credit worthiness is reflected in your credit history and expressed through your credit score. A bad credit history and score alerts lenders that there is a concrete risk of not being paid back. Lenders will protect themselves from the risk of default by applying very high interest rates or by not granting the loan at all.

Therefore, it is very difficult to get an unsecured loan when you have bad credit. And if a loan is made available to you, it will probably come with unattractive terms (such as a too high interest rate), not making it a viable option for consolidating your debt.

However, there is still the possibility of obtaining a loan with reasonable terms when pursuing one of the following:

1. Talk with a Credit Union

If you don't qualify for a debt consolidation loan from a bank because of your credit, consider applying for a loan through a credit union. Credit unions offer the same services and financial products as banks, but are nonprofit organizations owned by their depositors, members who share something in common.

Credit unions tend to be more sympathetic with people struggling with debt and charge lower rates, as they are less focused on earning a profit and more focused on providing a helpful and convenient service to their members.

Credit unions don't have to adhere to the same strict lending guidelines of big banks, so they can be able to extend you a loan even if you have a low credit score. They can better understand any unique circumstance that you might be facing or that might characterize your profile in an unique way.

You will need to join the credit union and become a member before you can get a loan. Membership is usually restricted to a specific geographical area or profession. Visit asmarterchoice.org to find a credit unions in your area. There are also some credit unions that anyone can join.

2. Peer to Peer Debt Consolidation Loans (if your score is at least 640)

Peer to peer or P2P lending allows you to borrow directly from an individual rather than from a traditional bank or financial institution. You can borrow up to $35,000 and the cash will be made available in a few business days. There is a closing (also called "origination") fee of up to 5%, but no prepayment penalties.

In contrast to banks, online peer to peer lending companies such as Prosper and LendingClub, are able to build a better borrower's profile by pulling data from various third-party sources, making loans available to many borrowers who would be denied elsewhere.

Still, P2P lending companies will check your credit when you apply, and your credit score is still an important factor in the approval decision. As of January 2014, the minimum FICO credit score required by both Prosper and LendingClub is 640. If your score is below 640, then you will not be approved for a P2P loan, so unfortunately you'll need to look elsewhere.

3. Use a Co-Signer

One possible solution is to ask a friend or family member to act as a co-signer. A co-signer is the guarantor of the loan and liable for your debt. If you default on the loan, the co-signer has a legal obligation to pay it off. Your co-signer will need to have good credit and sufficient income to qualify for the loan. For all practical purposes, a co-signed loan is an obligation of the co-signer and as such will be reported on his or her credit report. The co-signer outstanding debt amount will increase and late payments or a default would have a negative impact on his or her credit. Asking family members or friends to assume responsibility for your debt and potentially have their credit score negatively affected because of your financial problems might not be the best idea for the relationship.

4. Borrow from friends or family

If the person you considered as possible co-signer has plenty of savings in cash, he or she might prefer lending you the money directly. Compared to co-signing your loan, this option doesn't put his or her credit record at risk in case of default. To avoid complications, it is advised to always create and sign a written agreement that specifies the amount of the loan, the interest rate (if any), and the repayment terms. You can use a promissory note template from RocketLawyer or LegalZoom. Borrowing money from friends and family should be considered as a last resort because the normal equilibrium of the relationship might be altered when money is involved, damaged by potential misunderstanding, or even completely ruined if you are not able to repay the debt as agreed.

5. See a credit counselor

If the above options don't work in your case, and if you have already contacted your creditors, presented them your problem, and unsuccessfully tried to negotiate better terms that would allow you to make your payments, you might want to contact a credit counselor. Look for a nonprofit agency that is a NFCC member. Call 1-800-388-2227 or use the Online Counseling Request System

Avoid these "Bad Credit Loans" traps

Beware of companies that advertise loans for "good credit, bad credit, or no credit." Borrowers with bad credit are recurrent targets of predatory lending practices because they are in a weak position and desperate to get a loan. Here is a list of the various forms of predatory lending:

Payday or Cash Advance loans

The only requirement to qualify for a payday loan is having some form of income (or social security, or disability payments) and a checking account. A post-dated check or your electronic checking account information is used as collateral for this short-term loan. The loan has an extremely high interest rate, with the annual percentage rate (APR) ranging from 350% to over 700% in addition to administrative fees, late fees, non-payment fees, which can accumulate interest when unpaid. These loans are considered a form of predatory lending.

Short Term Loans

Similarly to Payday Loans, they come with interest rates ranging between 200% to 500%, and are another trap to avoid when looking for a debt consolidation loan for bad credit.

Tax Refund Anticipation Loans (RALs)

These are short-term cash advances against your income tax refund. The interest can be over 700% and the anticipation can be as little as only a week, compared to filing online and having your tax refund deposited directly into your checking account.

"Advance Fee" Scam

An advance fee loan doesn't even qualify as a case predatory lending. It is a scam. Anyone who guarantees you a loan in exchange for an advance fee is simply trying to get your money and disappear. Legitimate lenders never guarantee that you will get a loan and ask for an advance fee. If you fall into this trap, you will not get any loan and loose the money you send as an advance fee, which can range from $100 to several hundreds. For more information on this scam, consult the FTC Consumer Information section on Advanced Fee Loans.