Why your credit score matters for a personal loan
Loan eligibility depends on your credit score. A high credit score tells a lender that you have a history of managing money well. A lower credit score indicates that you've hit a rough patch. A financial institution is naturally more comfortable lending to a borrower with a strong credit history.
The impact of your credit score for a personal loan
The minimum required credit score for a personal loan may get you in the door, but individuals with higher credit scores tend to have better loan options.
When you apply for a personal loan, your credit score helps determine whether the lender approves your loan application. However, it also influences how much the lender will charge for that loan, including interest and fees. If you have an excellent credit score, you'll have the option of skipping over lenders that charge junk fees to take out a loan. However, borrowers with lower credit scores may have to determine whether they want a loan badly enough to pay unnecessary fees or whether they would rather wait until they can boost their credit score enough to qualify for a better loan.
Do you have a high-interest credit card balance you would pay off or loan debt that's holding you back? Whether you want to use a personal loan for debt consolidation or to put a swimming pool in the backyard, it's easier with a strong credit score. That said, even if your credit score is less than perfect, you have options.
What to do if you have bad credit
If you have a poor credit score (FICO® Score below 580) but you need a loan, there are several options to consider:
- Raise your credit score
- Apply for a bad credit loan
- Prequalify with several lenders
- Find a cosigner
- Offer collateral (get a secured loan)
We'll cover each of these in detail below.
Raise your credit score
The higher your credit score, the more likely it is that your lender will offer you a low interest rate. And the fastest way to raise your credit score is to pay off existing debt.
You should also check for errors on your credit report. The three credit bureaus -- Equifax, Experian, and TransUnion -- are each legally required to provide you with one free copy of your credit report per year upon request. You can request a copy of all three reports at once through a site like annualcreditreport.com.
Once the credit reports arrive, read through each one carefully, looking for mistakes. It may be something small, like listing the wrong address. It could be something big, like saying you owe money on a loan you never took out. If you find a mistake, notify the credit bureau that issued the report. Each of the credit bureaus has a dispute link on its website, making it easy for you to fix the problem.
Apply for a bad credit loan
There are lenders that offer personal loans for borrowers with low credit. If your credit score is below 600, you're considered either "fair credit" or "poor credit":
Credit score below 579: look for personal loans for bad credit.
Credit score 580 to 669: look for personal loans for fair credit.
Even the best personal loan for bad credit will come with a relatively high interest rate, but paying off your personal loan will raise your credit score. So the next time you need to borrow, your credit score should be in a higher range and you will likely qualify for better personal loan interest rates.
Prequalify with several lenders
Compare personal loans by getting prequalified with several lenders. When you've prequalified for a loan, the lender will let you know the rate and terms you're qualified for. This won't have an impact on your credit score because personal loan lenders typically run a "soft" credit check during the prequalification process. It's not until you decide which lender you're going to work with that the lender runs a "hard" credit check. While a hard check may ding your credit score a bit, it will quickly rebound after making several months of on-time payments. As the lender checks your credit report, they will also look at your credit utilization ratio. Credit utilization is calculated by dividing your monthly debt by your income.
Let's say your monthly debt payments amount to $2,100 and your income is $6,000. Your credit utilization ratio would be 35% ($2,100 ÷ $6,000 = 0.35). Here's why that matters: The lower your credit utilization, the more comfortable lenders are about granting final loan approval.
When you prequalify with multiple lenders, you should also compare fees. For example, one lender might offer a lower interest rate -- but charge a hefty origination fee. Pay attention to annual percentage rates (APRs) of different loans: The APR of a loan combines interest rate with fees to give you the true cost of a loan. Getting all the details ahead of time empowers you to choose the personal loan option that costs the least overall.
Find a cosigner
If you have a personal loan cosigner, that person's financial information and credit score could help you to qualify for a loan or receive better terms than you would on your own. That's because your cosigner will have the same level of responsibility as you on the loan.
This is an excellent way to get a good interest rate and attractive loan term, even if your credit score for a personal loan is low.
Offer collateral (get a secured loan)
One final option is to take out a secured loan against an asset where you've built up equity. Here are a few such options:
- A home equity line of credit (HELOC) where you take out a line of credit using the equity in your home.
- An auto equity loan where you take out a loan using equity in your car.
- A 401(k) loan where you borrow against your 401(k).
With a secured loan, you risk whatever you use as collateral. For example, with a HELOC or auto equity loan, you're putting your home or your car at risk should you default. Only take out a secured personal loan if you're confident you can make the monthly payment on time.
401(k) loans usually require you to have payments automatically deducted from your paycheck, but if you don't stick to the repayment plan, it could be costly. For example, if you lose your job and can't pay the loan back within five years, the loan could be considered a distribution. At that point, you'd likely owe taxes on it as well as a 10% early withdrawal penalty.
What about no-credit-check loans?
There are certain types of personal loans that don't require a credit check. Payday loans and car title loans are two common examples. However, they are short-term loans that tend to have very high interest rates, with APRs often exceeding 400%.
No-credit-check loans are a poor choice in all but the most desperate of situations. And even then, it's best to consider other options, like a loan from a family member or getting a loan with a cosigner. Even if you don't have a good credit score, avoid getting a payday loan or other no-credit-check loan at all costs.
The bottom line
There's an unsecured personal loan available for just about every credit score. The minimum credit score for a personal loan varies depending on the lender -- and that means you have options. If you absolutely need a loan, you can probably get one.
Your credit score will, however, determine the loan options available to you and how much interest you end up paying. For that reason, it's in your best interest to work on your credit score as much as you can and then shop around for the best low interest personal loans.
Any progress you make toward boosting your credit score will result in better loan options, potentially helping you score lower interest rates. Whether you borrow a little or a large amount of money, a strong credit score is one of the best ways to save money.
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