What to Know About Bad Credit vs. Installment Loans

If you’re in a financially precarious situation, but still need to get a loan for a car, you need to be aware of your options and know the difference between bad credit auto loans and what are considered installment loans. Read on to learn more and determine which one might be right for you.

What is a Bad Credit Loan?

car made from dollar

 

Generally speaking, these are loans that are extended to people who have spotty or poor credit scores and credit histories. How do you know if you qualify for a bad credit loan or if you have bad credit? Check your credit history with the major credit reporting agencies, like Equifax, Transunion, and Experian. These companies are required by law to provide you with a free copy of your credit report and score once a year. Review your history in order to fix any reporting discrepancies and understand what your credit score signifies.

Scores that fall below 620 are considered subprime. If, after checking in with the major credit reporting bureaus, you find that your score is less than 620, you’ll likely need to pursue a bad credit loan in order to secure a vehicle. Just because you’re in a less than ideal situation doesn’t mean you don’t have options. The trick is understanding them in order to make an informed decision that will best benefit you in the long run. 

fico-credit-score-chart

So, what is a bad credit loan?

Basically, a bad credit loan is a loan that comes with a higher interest rate. According to the Department of Motor Vehicles, available auto loan rates for consumers with average credit tend to fall between five and six percent. However, with shaky credit, you might be looking at an APR of thirteen percent or more. Now, even with a bad credit auto loan you might be able to rebuild your credit by making monthly payments on time and in the full, agreed upon amount. In fact, if we have some helpful tips for getting an auto loan, even if your credit is less than stellar.

An installment loan sounds similar, but there are some important nuances you need to keep in mind. 

What is an Installment Loan?
Car Keys. Seller hand giving keys

 

Just as it sounds, an installment loan is a kind of loan that is paid off over the course of a specific number of scheduled payments, or installments, over a set period of time. Installment loans include the principal of the purchase itself, and the interest.

So, what’s the difference? Why should you be especially careful if you opt for an installment loan? 

Because, according to a Lauren Saunders, a managing attorney at the National Consumer Law Center, “Some installment loans have exorbitant rates, deceptive add-on fees and products, loan flipping, and other tricks that can be just as dangerous, and sometimes more so, as the loan amounts are typically higher.” Time magazine covered what it deemed the “dirty secrets” of installment loans in a 2013 article and identified the problem as the result of the fact that these loans look attractive because they advertise very low monthly payments, which can seem like a great deal if you’re struggling financially and can’t manage to pay much more than that at a given time.

But, consider this one example of a consumer who took out a loan to cover the costs of car repairs, which totaled $207. This consumer agreed to an installment loan, with the terms set for seven monthly installments or payments of $50. So, what cost $207 in repairs, actually amounted to $350 out of her pocket. 

And there are other pitfalls to consider… 

The “One Time” Fix Reputation…

…that installment loans are known for is, in fact, false. Installment loans are advertised as quick, one-time fixes to a cash flow problem. However, because they are so easy to renew, most consumers continue to roll one loan into another. One number puts loan renewal frequency at 77 percent, meaning that 77 percent of consumers who agreed to an installment loan to solve a one-time cash issue actually ended up renewing that loan. 

Why is this a problem?

A recent investigation by ProPublica, an independent, non-profit news organization, involved interviewing former installment loan officers, all of whom were trained to convince consumers to extend their loans by renewing. One fomer loan officer admitted, “Every single time they had money available, (the goal was) to get them to renew, because as soon as they do, you’ve got another month where they’re just paying interest.” As consumers renew these “one-time” loans, their APR increases. According to that same report by ProPublica, APRs on installment loans can be as high as 90 percent, but that number increases as consumers repeatedly renew.

The payments generally satisfy only the interest, and don’t even make a dent in the principal. This is an intentional design. Consumers pay more in interest, but never make much progress with respect to actually paying off the principal and clearing the debt. A consumer interviewed by ProPublica discovered that she was actually paying more than 800 percent on two installment loans which were more than a decade old. The reputed “affordability” of these loans is questionable, as they can end up costing so much more, long-term.

A Better Loan Option

customer and salesman with car key

Work with a trusted source for your lending needs. Even better, approach an agency with whom you already have a relationship. That could be your bank, credit union, or other legitimate lender. It’s a numbers game, and the trick is knowing your own as far as your credit score and history are concerned, and reading the fine print with respect to loan terms and interest rates. If a deal sounds too good to be true, it likely is. Evaluate how much you can pay each month, and make that payment as reasonably high as possible so that you’re paying more than just the interest. When in doubt, consult with a legitimate credit counselor to help you find a more solid financial footing. The Federal Trade Commission has a website to help you find the right credit counselor, and navigate your debt relief. 

As the saying goes, “knowledge is power.” You can buy a car or certified pre-owned vehicle with bad creditArm yourself with research and enjoy a more confident approach to correcting your credit history and rerouting your financial future. You’ll be behind the wheel and well on your way in no time.