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High-Risk Loans: How They Work And Why To Avoid Them

Miranda Crace7-minute read
PUBLISHED: March 22, 2024


Your credit score is often your main asset in getting a loan, so people with poor credit can have a tougher time borrowing money. That doesn’t mean it’s impossible to get a loan if your credit score is low, though. Some lenders offer “high-risk loans” for borrowers with a low credit score to have access to the funds they need. However, these loans often come with a higher interest rate and fees, along with collateral requirements.

Have a look at our complete guide to high-risk loans and some safer financing alternatives.

What Are High-Risk Loans?

High-risk loans, compared to how traditional personal loans work, are riskier for a lender to approve due to various factors. For example, with this type of loan, borrowers typically have a greater likelihood of defaulting or failing to repay the full loan amount. As a result, lenders often need more assurance they’ll be repaid in some fashion.

Because of the higher risk, these loans usually come with a high annual percentage rate (APR), as well as finance and rollover fees.

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Types Of High-Risk Loans

There are several well-known high-risk loans, which we’ll discuss next.

Payday Loans

Payday loans are short-term loans typically limited to smaller amounts up to $500. The repayment term on a payday loan may last only 2 weeks, or repayment will likely be due whenever you receive your next paycheck. Borrowers typically repay the full loan amount in a single payment or roll their payment over to another term, which is costly.

Payday lenders impose an APR of nearly 400% and charge $10 – $30 lending fees for every $100 borrowed. Rolling the loan over incurs another lending fee every time you extend the due date. Because of these high costs and the likelihood of rollovers, it’s best to avoid payday loans.

Title Loans

Car title loans are secured by your vehicle’s title, which the lender keeps as collateral until you can pay off the loan. Loan amounts tend to be 25% – 50% of your vehicle’s value, but this amount can vary from one lender to the next.

The loan term for title loans can last 15 – 30 days, and monthly rollovers incur a charge of 25% of your loan amount. Additionally, the APR for title loans is around 300%, in addition to a 25% finance fee. Worst of all, if you can’t repay the loan, you lose your vehicle to the lender.

Pawn Shop Loans

Pawn shop loans are also secured by collateral, but not necessarily vehicles. Valuable assets often used as collateral include jewelry, electronics and various personal possessions. In exchange for their collateral, borrowers can receive 15% – 60% of their item’s resale value in cash.

Loan amounts for pawn shop loans average around $150 with a 30-day term. Your interest rate can eclipse 200%, and lenders will charge varying fees. If you can’t repay the loan by the due date, the lender may sell your item to recapture the funds you’ve borrowed. It may be possible to roll the loan over, but you’ll have to pay another fee.

High-Risk Personal Loans

Some lenders offer “bad credit” personal loans to borrowers with a low credit score or no credit history. These loans will likely come with a high interest rate, fees and a stricter repayment term than a traditional loan.

Lenders that approve high-risk personal loans often require a certain minimum income, and possibly collateral, to secure the loan.

What Makes You A High-Risk Borrower?

The state of your credit score tells a lender whether you’re a high-risk borrower. Those with a credit score above 580 – 600 are typically viewed as low-risk borrowers, while people with a score below this range will likely be seen as a higher risk.

A borrower will also likely be considered high-risk if they have:

  • High credit card balances
  • A credit history showing defaults or late payments
  • A short credit history
  • Self-employment or the absence of full-time employment
  • A high debt-to-income ratio (DTI) (over 36%)
  • A recent declaration of bankruptcy

Check your credit report as well as your credit score for any other signs of being high-risk.

What High-Risk Lenders Look At

Many high-risk lenders won’t perform a soft or hard inquiry into your credit. Instead, lenders will often have a few basic requirements.

For example, borrowers should be age 18 or older, be an American citizen, have reliable income and an active bank account in their name. You must also provide personal identification, such as a driver’s license or passport, etc. Most lenders will also require proof of income.

Requirements vary among lenders, but meeting these basic requirements will usually be enough to get approved for a high-risk loan.

Signs Of Predatory High-Risk Loans

Many high-risk lenders are known to practice predatory lending tactics. Here are some signs that you’re dealing with a predatory lender:

  • The lender charges high fees and high interest rates.
  • The lender offers no or little transparency around fees, APR, etc.
  • The lender tries to sell you loan add-ons at extra costs.
  • The lender doesn’t require proof of income.
  • The lender has few, if any, positive customer reviews online.

You’ll want to avoid lenders that present any or all of these signs.

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Why You Should Avoid High-Risk Loans

People may turn to high-risk loans if they need immediate funds or they’re unable to qualify for more traditional loans. However, high-risk loans come with substantial drawbacks that could put you in a worse spot than you started in.

First off, the high APR and fees can add up quickly, particularly with the addition of rollover fees if you need to extend your due date. You could end up paying a huge cost for borrowing a relatively small loan.

Second, since many high-risk loans require collateral, you risk losing any assets or items you used to secure the loan. In the case of a car title loan, you could lose your main mode of transportation.

Lastly, the shorter repayment term increases the risk you’ll need to roll your loan over, incurring additional fees and interest charges. You could find yourself trapped in a debt cycle and need another loan just to get out of it.

Alternatives To High-Risk Loans

Even with a low credit score, you don’t have to take your chances with a high-risk loan. Here are some safer alternatives for high-risk borrowers.

Getting A Secured Personal Loan

Some personal loan lenders offer secured loans with a more lenient credit requirement in exchange for collateral. You could even qualify for a lower interest rate with a secured loan. Make sure you can keep up with your monthly payments, though, to avoid the possibility of losing your collateral as well as defaulting on the loan.

Consulting Your Financial Institution

Meet with a representative of your bank or credit union to discuss potential financing options. Some financial institutions can offer special deals for longtime clients, or they can use other information from your personal finances to determine your loan eligibility.

Using A Co-Signer

A co-signer can sign onto your loan application with you to give your creditworthiness a boost. Lenders may approve co-signed loans for high-risk borrowers because the co-signer will be responsible for the loan if the borrower defaults. Applicants with a qualified co-signer may qualify for a larger loan with a lower interest rate.

Exploring Online Lenders

Certain online lenders may be more flexible in their credit requirements, and they may focus more on your income when deciding whether to approve you for a loan. Peer-to-peer (P2P) lending platforms can help connect you with lenders and investors willing to issue you the loan you need.

Asking Family Members Or Friends

Consider asking family members or perhaps friends for a loan. The lender and borrower will need to agree on the interest rate and term for a family loan, but you could have no interest rate at all if your family member is okay with it. Although family loans tend to be relatively informal, it’s still wise to have an attorney present to draw up a loan contract.

Building Up Your Credit Score

You can improve or build up your credit score in a number of ways. For example:

  • Make on-time payments.
  • Seek credit counseling.
  • Apply for a credit-builder loan.
  • Become an authorized user on a credit card.

Raising your credit score can help you qualify for more traditional loans, including a personal loan.

High-Risk Loan FAQs

Take a look at these frequently asked questions about high-risk loans, followed by their answers.

What is considered a high-risk loan?

A high-risk loan will usually have a high interest rate, short repayment term, collateral requirements and a relatively low loan amount. Lenders will typically forego a credit check and approve a loan based on a borrower’s income or other borrower qualifications.

Which loan has the highest risk?

Unsecured loans are the riskiest for lenders to approve, because the lender doesn’t require collateral for reclaiming their lost funds if the borrower defaults. Payday loans don’t require collateral but can charge an exorbitant interest rate and extremely high fees.

What credit score is considered a risk?

As mentioned, a lender will likely consider a credit score lower than 580 – 600 (using the FICO® scale) to be high-risk. The higher your credit score, the lower risk you are for a lender to approve.

Final Thoughts

Borrowers with a poor credit history may seek out high-risk loans for quick and accessible funding, but it’s a good idea to consider the potential drawbacks. High-risk loans usually come with a triple-digit APR along with finance and rollover fees, and they may have a collateral requirement.

Paying back the money on a high-risk loan could drain your finances and leave you in a cycle of debt. If you have an opportunity to take advantage of an alternative loan option or build up your credit, we recommend trying that first.

Want to view your options for a personal loan? Start an application today with Rocket Loans℠.

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Miranda Crace

Miranda Crace is a Senior Section Editor for the Rocket Companies, bringing a wealth of knowledge about mortgages, personal finance, real estate, and personal loans for over 10 years.