Different Types of Loans For Credit Challenged Consumers

Bad Credit Lending

Some lenders are actually in the business of extending new credit to individuals with a history of credit problems or bankruptcy.  If you have credit problems in your past, don’t be surprised if you start receiving offers like this in the mail or possibly even by phone.  These offers may sound like the same types of credit you’ve had in the past, but often they are not.  The interest rates and fees may be much higher, as well as include stiffer penalties for things like late payments. There are a number of different types of bad credit loans for credit challenged consumers.

Predatory Lending

Offers may come from “predatory lenders” who count on you to default after having collected profits from the fees and payments you have already made.  In years past, having credit problems would make getting new credit difficult, if not impossible.  Statistics now show that after filing bankruptcy, many people will find offers for credit cards actually increase, and may be from predatory lenders.  Examine all new offers to extend credit very carefully.

Unsecured loans are loans that are not tied to any property or collateral, meaning that the creditor has no specific claim to your property for this type of loan. Creditors issuing these types of loans are known as “unsecured” creditors.

The most common types of unsecured loans are:

Signature Loans -   These loans are based entirely on your promise of repayment. You don’t need to provide collateral, and the loan proceeds aren’t limited to any particular purpose. You sign formal loan documents agreeing to repay the debt according to the terms of the agreement. A signature loan from a bank or credit union is a common type of unsecured loan. The bank lends you the money, but can’t take possession of your car or home if you default.

Credit and Retail Cards -   Although some credit cards are “secured” by a cash deposit that’s held by the card issuer as security against the charges you make, most credit and retail cards are like signature loans, in that they’re issued based on your promise to make payments as agreed, with no collateral. The credit card company lends you the money to make a purchase, but doesn’t require the item to be returned to them in the event that you don’t pay. Credit cards are the most common type of Revolving Credit, which is a type of “loan” that lets you borrow up to a set credit limit, or maximum amount you can borrow or “charge” on that account. Then, and as you pay down your balance, you’re able to borrow again any amount up to the credit limit. Is a credit card for people with bad credit bad? Certainly is can be if spending habits are not significantly changed.

Payday Loans -   These are cash advances made against your paycheck. The lender will usually hold a personal check written by the borrower until payday, and then the loan company cashes the check, or the borrower pays a fee to extend the loan. Fees for payday loans can be very expensive, so be careful when considering this option. The flat fee that the lender charges for these short term loans may look low, but when figured as an APR, the interest may be several hundred percentage points high. Compare that with mortgage rates which are usually single digits or in the low teens, and you’ll understand why payday loans should be used for emergencies only, if at all.

Family and Friends – Among the most helpful of loans, the fees on these are usually very low or nonexistent. But the pressure to repay can be great. Even if you don’t repay a “friend” or “family” loan, you risk significant strain on, or even loss of, the relationship.

Although Unsecured Loans are not backed by collateral, the creditor may try to sue to win a judgment if the loan is not repaid. A judgment will generally accrue interest until it’s resolved, and can haunt the borrower for years to come. Creditors who obtain a judgment can then place a lien against property like your home, or attempt to garnish your wages or bank account in order to get the amount awarded to them by the court.

Secured Loans

Secured Loans are backed by a lien, or a legal right, on property that’s designated as collateral for the loan. To put it simply, if the borrower defaults on the loan, the “secured” creditor has the legal right to take possession of the collateral. Mortgages and auto loans are the most common types of Secured Loans, and the home or car itself serves as collateral for the loan. Pawn shop loans are another type of Secured Loan.

Unlike credit cards which, as we’ve discussed, are revolving lines of credit, secured loans are typically paid on installment. An installment loan starts off as one lump sum that you pay down over time, and once you’ve made your last contractual payment, the loan is closed and you become the outright owner of whatever served as collateral for the loan. Installment loans are based on a principal amount, which is the remaining balance owed of the original amount you borrowed, excluding interest and taxes. And the loan term is the length of time it will take you to repay the total loan amount, meaning the principal plus the interest.

Mortgage Loans -   The largest purchases most people make are cars and homes. Because the cost of a home is so high, it’s often the largest credit purchase people will make in their lives. A mortgage is a contractual agreement that provides you with the funds required to purchase the home, but gives the lender the right to take possession of your home if you fail to meet your loan obligations. Mortgage loans are usually for fifteen, twenty or thirty years. Shortening the mortgage term will increase the monthly payment, but significantly reduces the total amount of interest paid.

Automobile Loans -   Auto loans are usually our second largest credit-based purchases. Most auto dealerships have financing options available, but many financial planners advise that you contact several lending institutions to explore your loan options before you talk to the dealership. An auto loan works more or less the same as a home loan, but for a smaller amount and for a shorter term, usually three to six years.

Pawn Shop Loans -   Pawn shops offer you cash in return for an item of greater value, which the pawn shop holds as collateral. If you don’t repay the loan and the substantial fees in full by the due date, the pawn shop sells the item.

Non-Purchase Money Loans -  These are loans in which an item owned outright by the borrower is used as collateral for a money loan, like when an automobile that the borrower paid cash for is now used as collateral to get a cash loan for some other purpose.

Comparison Shopping

It is important to carefully weigh all your loan options before making a decision. There are two main things you need to consider before accepting a loan – Interest Rate and Loan Terms.

Interest Rate

The interest rate is one of the most important factors to consider when comparing loan products.

* What is the interest rate?
* Is the interest rate fixed or variable?
* What is the Annual Percentage Rate?
* How much interest will you pay over the life of the loan?
* Is the interest rate for your loan comparable to the rates other lenders are offering?

Loan Terms

When you sign loan documents, you agree to all the terms of the loan. It is very important that you read and understand all the terms of your loan.

* How much is the monthly payment?
* How can you make your payment?
* How long will it take you to pay off the loan?
* Is there a penalty if you pay off the loan early?
* What fees do you have to pay to get the loan?
* Does your loan include credit life insurance? Do you need it?
* If you are getting a loan to finance a product (e.g., car, applicances, furniture), when you factor in interest, are you going to pay more than the product is worth?
* What are the late fees?
* When are late fees assessed?