Why Online Personal Loans for Bad Credit Should Be Avoided

Do you have overdue medical bills? Are you trying to save your house from a foreclosure? Are you facing unexpected car repair costs? When the bills are piling up, it’s not always easy to make good financial decisions. But, even if you feel like you need to get your hands on some fast cash, don’t jump at the easiest opportunities. If you make a bad choice, you’ll just get yourself deeper into debt.

If you need money in a hurry, one option you should generally avoid is getting a personal loan online. Over the past few years, personal loans with sky-high interest rates have become readily available over the Internet as online lenders target people who are struggling to pay their bills. These kinds of loans are best avoided. Read on to find out why. (To learn about other options to avoid, see What to Avoid When You Need Money.)

How High-Interest Personal Loans Work

Unlike car loans or mortgages (or deeds of trust), personal loans don’t require you to pledge collateral in exchange for borrowing money. To get this kind of loan, a borrower simply goes online and provides basic personal information, like a name, address, Social Security number, and bank account number.

An Expensive Way to Borrow Money

Online lenders tend to offer personal loans for amounts starting between $1,000 and $3,000. The interest rate you’ll have to pay on the borrowed amount is based mainly on your credit score, but the lender might also consider other factors like your income, occupation, and education level. If you have bad credit, you’ll likely still get the loan, but you’ll have to pay a higher interest rate. Unsecured personal loans found online regularly have annual percentage rates (APRs) well over 100%, which means you’ll pay a massive amount of interest over the life of the loan.

Example. Suppose you borrow $5,125 at an annual interest rate of 116%. You agree to repay the loan over roughly seven years, paying $495 on a monthly basis. In total, you’ll end up paying around $42,000, including nearly $37,000 in interest.

Lenders also sometimes charge an origination fee, which is typically between 1% and 5% of the loan amount, as well as other fees, like documentation fees. Consumer advocacy groups generally consider these kinds of loans predatory in nature because they target desperate borrowers taken in by aggressive marketing and promises of quick, easy cash.

Taking Out a Personal Loan Can Hurt Your Credit

While taking on debt has always had an effect on credit scores, under FICO's 10 T scoring model, introduced in 2020, people who take out personal loans could get an even lower score than under other scoring models. Consumers who transfer their credit card debt to a personal loan, and then accumulate more credit card debt, in particular, will probably see their credit scores fall.

How High-Interest Personal Loans Differ From Payday Loans

Payday loans, which can have even higher APRs, normally have to be paid off within a few weeks. The repayment term on a high-interest personal loan, however, is generally a year or longer.

State law sometimes caps the dollar amount for payday loans and may limit the interest rate that the lender can charge. But state law might not limit the interest rate when it comes to unsecured personal loans of a certain dollar amount. For example, California has laws covering payday loans and provides interest-rate caps for installment loans of less than $2,500, but there’s no cap on interest rates for larger loans. (Cal. Fin. Code § 22370). (To learn why you should also avoid payday loans, see Should I Get a Payday Loan?)

Other Options to Consider

If you're struggling to pay your bills, consider options other than taking out a high-interest personal loan.

• You might be able to get a loan from your local credit union. (You'll likely have to join the credit union if you aren't already a member.) A credit union might be willing to look at factors other than your credit score when assessing you for a loan. But if you have really bad credit, you probably won’t qualify.
• You might be able to get an advance or emergency loan from an employer, nonprofit organization, or community group. (For example, if you're facing a foreclosure in Connecticut, you might be able to get a loan from the Connecticut Housing Finance Authority that will bring your mortgage current and cover monthly payments for a while. To learn more, see Avoid a Connecticut Foreclosure: Getting Help From CHFA.)
• You might be able to negotiate with a creditor or debt collector to lower the overall amount you owe. (Learn strategies for negotiating with creditors and debt collectors.)

If you decide to take out a high-interest personal loan—even after reading about how expensive they are—keep in mind you can save thousands of dollars by paying off the debt early. Many high-interest personal loans don’t charge a prepayment penalty.

Getting Help

If you’ve defaulted on a high-interest personal loan and the lender or a collection agency is hounding you for payment, or if you’re being sued for payment, consider talking to a debt settlement attorney to learn about your rights and find out what you should do in your situation. An attorney might be able to help you arrange a settlement or a modification of the loan.