Bad Credit LoansBy Bryan in Posts
Unfortunately, lots of Canadians have problems getting loans due to their poor credit ratings. There have also been many other economic setbacks all across North America over the last few decades. Those setbacks, of course, can lead to high levels of household debt and bad credit among Canadian borrowers. Then again, it can be tough to attribute the idea of bad credit to anyone financial issue. There are plenty of other factors that can cause someone’s credit rating and credit score to drop, such as consumer proposals and bankruptcies. Ultimately, however, the outcome is the same. Whether the product they seek is as expensive as a mortgage or as inexpensive as a regular short-term loan, many mainstream lenders, such as banks, are often unwilling to approve these bad credit borrowers.
However, this is where the subprime lender steps in. There are now a number of institutions that cater specifically toward borrowers with bad credit, offering loans and other credit products without the restriction of a high credit rating and score. If you’ve got a low credit score, don’t worry, there are places you can go to be approved for the products you need.
What Qualifies as “Bad Credit”?
In Canada, as soon as you’re approved for your first credit product, your lender will notify one (or both) of Canada’s credit reporting agencies, Equifax and TransUnion. That agency will then compile all your credit-related information into a credit report. As its name suggests, a credit report functions somewhat like a report card you would get from school, wherein all your credit activity (payments, transfers, cancelled accounts, etc.) will be listed. This activity can be the cause of your bad credit, which we’ll elaborate on further below.
To learn more about how credit reporting agencies operate, click here.
What is a Credit Rating?
Each active credit account you have also come with a “credit rating”, identified by corresponding letter and number. If you’ve been managing the account responsibly, meaning you’ve been making your bill payments on time and in full, you’ll have a high rating. However, if you’ve been making late or short payments, or even worse, missing them entirely, your rating will drop. The rating system is as follows:
– “I”: means your loan is “installment” based, so you’ll be making divided payments (weekly, monthly, etc.) over a specified period of time until the full sum is repaid.
– “O”: means you have “open” credit, commonly seen with lines of credit or student loans. You’ll have a credit limit, which you can borrow from as needed. You’ll also have a minimum monthly balance payment to keep up with in order to avoid a penalty.
– “R”: means you have “revolving” credit, the most common type of credit rating. Once again, your regular payments will depend on your account balance. The most frequent example of revolving credit is a credit card.
Beside each letter, you’ll also be assigned a number that corresponds to how you’ve been managing the account in question. *Note: we’ve used “R” (revolving) as an example, but the numbers can coincide with any of the above letters.
R0: Too little credit history or the account is unused.
R1: The account holder pays (or has paid) within 30 days of payment due date or not over one payment past due.
R2: The account holder pays (or has paid) in more than 30 days from payment due date, but not more than 60 days, or not more than two payments past due.
R3: The account holder pays (or has paid) in more than 60 days from payment due date, but not more than 90 days, or not more than three payments past due.
R4: The account holder pays (or has paid) in more than 90 days from payment due date, but not more than 120 days, or four payments past due.
R5: The account is at least 120 days overdue, but is not yet rated “9.”
R6: This rating does not exist.
R7: The account holder is making regular payments through a special arrangement to settle their debts.
R8: The account is in repossession (voluntary or involuntary return of merchandise).
R9: The account is in significant debt, has been placed in collections or bankruptcy, or the account holder has moved without providing a new address.
For a more detailed explanation of credit ratings and credit scores, click here.
What is a Credit Score?
Your three-digit credit score is another significant factor for lenders when they’re determining your creditworthiness. In Canada, credit scores range from 300-900. According to TransUnion, a score of 650 or higher is what borrowers should ideally have to receive the best chances of approval for credit products, as well as more favorable interest rates to go with them. The further your score is below 650, the more your chances of approval will decrease and the higher your interest rates will be.
To learn more about your Canadian credit score, check this out.
How Your Credit Becomes “Bad”
If your credit score and rating have gotten to the point when lenders consider you a borrowing risk, it means that you’re in the realm of bad credit. As we said, this point is usually reached after a history of irresponsible credit usage. This could mean you haven’t made your bill payments on time and in full. Maybe you’ve experienced one or more financial delinquencies, such as a bankruptcy, or other types of bad debt caused by a string of defaulted transactions. As a result, your credit rating and score will be low.
Take a look at our infographic to see how bad credit affects your daily life.
When you apply for a new credit product, lenders will often pull a copy of your credit report and examine it to determine your creditworthiness before they approve or deny your application. This is known as a “hard inquiry” and will also cause your score to drop a few points. During their examination, they will see your poor credit history (if any) and may come to the conclusion that you’ll have a problem managing your future payments. Many commercial lenders, banks, in particular, have strict lending rules. Therefore, if you have bad credit, your applications may not be approved and you might need to seek out a subprime lender who deals specifically with borrowers in your situation.
To find out more about credit inquiries, look here.
What is a Bad Credit Personal Loan?
Some of the more frequently seen products among bad-credit borrowers are personal loans. These loans can be used to cover almost any expense, such as home repairs/renovations, household supplies/groceries, etc. There are plenty of subprime lenders who offer these. Bad credit personal loans function in more or less the same fashion as regular personal loans, in that they are installment-based.
To learn how to qualify for a personal loan, click here.
Drawbacks to a Bad Credit Personal Loan
Generally speaking, personal loans are a type of “unsecured” debt, meaning no collateral is involved when you apply for one. Collateral refers to the assets you may offer up, to be secured against the loan, such as your home, car or another piece of property that’s of significant value. If your debt is labeled as “secured”, it means your lenders have the right to repossess and sell your assets as a way to compensate for their loss, if and when you default.
However, since most personal loans are unsecured, only money will be involved. This is where a lot of borrowers get themselves into trouble. Like any credit product, personal loans need to be managed properly to avoid a penalty. Every time you miss a payment, your lender will likely charge you a penalty fee and a higher interest rate. Since bad credit loans already come with higher interest rates than normal ones, your debt level might only get worse. Then, if you default for too long, after a certain point, your lender might even sell your debt to a collection agency. This, in turn, can lead to a court case and wage garnishment, if your debt is large enough to justify legal action.
Why are Bad Credit Car Loans in High Demand?
Another in-demand credit product with bad credit borrowers is the car loan, which many subprime lenders also offer. These kinds of loans have become increasingly popular because of the wide range of automotive problems they can help fix. So, when applying for a car loan, bad credit borrowers will need to outline exactly what they intend to use it for. That could be anything from necessary repairs for their existing vehicle to acquiring the car’s title, to paying for the car itself from a private seller or a dealership.
Read this to learn how to get a bad credit car loan in Canada.
Drawbacks to a Bad Credit Car Loan
A car loan is similar to a payday loan (which we’ll explain below) in that both types of application are processed rapidly and will receive approval within one or two days if the borrower qualifies. This is another reason why car loans can be appealing to borrowers with bad credit.
However, just like personal loans, problems arise when it comes to the interest rates and payments, which the borrower may end up struggling to deal with. Because the borrower has bad credit, once again their interest rate can end up being very high. These costs can land the borrower in even worse debt than they were before. Then, not only will they be in considerable debt, they may end up paying much more for their car than it’s actually worth. The debts that come with most car loans are also secured. If the borrower defaults for too long, the lender or dealership could seize the car as collateral.
Click here to learn what to do when your car loan is more than your car is worth.
What is a Payday Loan?
“Payday” loans are the third most common type of loan. They’re aimed toward Canadians with poor credit, who need a relatively small amount of quick cash, often $1,500 or less. These loans sound appealing because they are easy to acquire. In fact, they usually have same day approval, making them attractive to those with an emergency financial situation on their hands. If a borrower needs a few hundred dollars to pay their rent, they can walk in off the street, get approved and walk out with the cash in a matter of hours. All they need is proof of employment and an active chequing account. They’ll then typically have two weeks or the length of a regular pay cycle to reimburse what they owe without incurring more interest.
Drawbacks to Payday Loans
That brings us to the most unfortunate drawback of all payday loans, the interest rate. Since payday loans are generally for small amounts, the way their businesses make a profit is by charging extremely high-interest rates, sometimes as much as 500% APR (annual percentage rate). So, if you were to borrow that same few hundred dollars for rent, but didn’t manage to pay it back by the due date, you could be charged a huge amount in interest. As a result, you could end up paying hundreds of dollars more for what should have been a relatively small, one-time loan.
Check out our infographic to learn more about the Payday Loan Cycle.
What is a Debt Consolidation Loan?
As a last resort before debt management programs, consumer proposals and bankruptcies, borrowers with bad credit can also apply for “debt consolidation” loans. Similar to personal loans, debt consolidation loans are available through both prime and subprime lenders. However, consolidation loans are made specifically for the purpose of eliminating smaller debts.
Like any typical loan, you’ll need to go through an approval process to determine your eligibility. If approved, you’ll use your consolidation loan to pay off all your other debts (payday loans, credit card bills, etc.) in one go. Afterward, you’ll only have one monthly payment and one, usually lower interest rate to keep up with, both of which you’ll pay toward a single lender, rather than multiple organizations. This can make the whole payment process far more efficient to deal with. Depending on their size, debt consolidation loans are usually meant to be paid off within 2-5 years, which can be quicker than with would have been your numerous other debts.
Want to know how consolidation can help your financial situation? Find out here.
Drawbacks to Debt Consolidation Loans
First of all, consolidation loans are not always easy to get approved for. While they are often catered toward borrowers with bad credit, people with very low credit scores (under 500) may still have a hard time getting approved. On top of that, potential borrowers also need a good source of income, a high net worth, possibly co-signer and valuable assets. Borrowers may be able to get an unsecured consolidation loan, but their interest rate will likely be higher than that of a secured loan, which is another obstacle to consider.
Did your application for a debt consolidation get denied? Here’s what to do.
Once again, if the regular payments are not managed properly or the payment schedule is not honored, it could land the borrower in even more serious debt than before. Suffice to say, if you’re thinking of applying for a debt consolidation loan, be certain that you understand what you’re dealing with. Always make sure to discuss the idea with a financial advisor and be certain your finances can support the payments.
For more ways of repairing bad credit, read our other article.
Which Bad Credit Loan is Best For You?
In the end, which loan product you use for your bad credit situation is dependant on you and your particular financial position. If you’re interested in knowing what your bad credit loan options are, Loans Canada can help.