Income-based loans: How they work and who they work for

Your credit history is a significant factor lenders consider when deciding whether to approve your personal loan application. If your credit history has some flaws, you may want to consider an income-based loan as an alternative. Income-based loans have some downsides, including slightly higher interest rates. It may be a good option if you have steady employment and a stable income, but your credit history isn't ideal.

Key takeaways:

• An income-based loan allows you to qualify based on your income rather than your credit history.
• To apply for an income-based loan, assess your income and creditworthiness, research different lenders, and get prequalified before you complete an application.
• Banks, credit unions, and online lenders offer income-based loans, but you should avoid predatory lenders.

If an income-based loan isn't right for you, consider a traditional personal loan, 0% APR credit card, home equity financing, or a family loan.

What is an income-based personal loan

An income-based loan is a personal loan where the lender evaluates your application based on your income instead of your credit score. These are loans based on employment not credit. The amount you can borrow and the terms you’re offered depend primarily on your having stable employment and sufficient income to repay the loan.

How much income do you need to get a loan? It varies depending on how much you plan to borrow, how much you earn, and the lender's policies. In general, you'll need to show the lender you earn enough to afford the loan payment.

Income-based loans can be secured or unsecured. A secured loan requires collateral, which makes the loan less risky for the lender and, therefore, easier to qualify for. Secured loans typically have lower interest rates than unsecured loans.

Preapproval for an income-based loan usually requires a soft credit check. This doesn't affect your credit score, but still allows the lender to see your credit report.

Income-based loans often have higher interest rates than traditional personal loans, primarily because lenders perceive them as riskier. Higher interest rates translate into a higher monthly payment, which means you'll need more income to qualify than you might for a credit-based personal loan.

Secured vs. unsecured loans

An unsecured loan requires no collateral. The lender determines your ability to repay the loan based on your income and credit. Because the lender assumes most of the risk, unsecured loans typically have higher interest rates, especially for borrowers with low incomes or poor credit.

A secured loan requires collateral, such as a bank account or physical asset. Often, a secured loan uses the asset being financed as collateral. For example, the car you're buying secures an auto loan, and the property you buy secures a mortgage. If you fail to repay the loan, the lender keeps the collateral as compensation for its losses. More risk falls on the borrower, so lenders may approve a secured loan for borrowers with lower credit scores or offer lower interest rates.

Pros and cons of income-based loans

Before you submit an income-based loan application, it's important to consider the pros and cons.

How to apply in 6 steps

The process of applying for an income-based loan is a lot like applying for any other type of loan, and it starts with ensuring you meet all the loan requirements.

1. Assess your income and credit: Before you start the application process, it's important to understand where your finances sit. Make sure to review your current income and calculate your debt-to-income ratio (DTI). You should also check your credit score. If you have good credit, a traditional personal loan may be a better option.
2. Research lenders: With so many lenders on the market, it's important to do your homework. Research the lenders that offer income-based loans and find those with interest rates, fees, loan amounts, and repayment terms that fit your needs. Some lenders may allow you to get prequalified or preapproved with a soft credit check, so you can easily compare rates.
3. Apply for a loan: Once you have found the best lender for your situation, complete the application. You'll submit financial information and documentation, including proof of income.
4. Wait for approval: Depending on the information you share in your application, your loan may be approved immediately or within a few business days.
5. Receive your loan funds: Once your loan is approved and you sign your loan documents, you'll receive the loan funds in your bank account.
6. Start loan repayment: Once you receive your loan funds, your loan will enter repayment. Make sure to make every payment on time, as missed or late payments can negatively affect your credit score.

Where to find lenders and red flags to avoid

You may apply for income-based personal loans with traditional banks, credit unions, and online lenders, but they may look different depending on where you get them.

For example, loans from traditional lenders likely will require a hard credit inquiry. They may not set a minimum credit score, but they'll still take your payment history into account. Other lenders will require only the soft inquiry.

However, not all lending institutions offer income-based loans, so you may have to shop around.

When shopping for loans, avoid predatory options, such as payday loans and car title loans. Payday loans often have interest rates nearing 400%, making them difficult to repay. They often lead to a debt cycle that's difficult to escape. Meanwhile, car title loans require you to put up your car as collateral, meaning you'll lose your vehicle if you can't repay the loan.

If you're planning to apply for a personal loan, you can increase your borrowing options by taking steps to improve your credit score. For example, getting up-to-date on your debt payments and lowering your credit-utilization ratio can raise your score.

Alternatives to income-based loans

Income-based loans may not be the right choice for everyone. Here are some alternatives to consider.

Traditional personal loans

Traditional loans usually have lower interest rates than income-based loans. You'll typically need a credit score of at least 650 to secure the best rates, but even a score of 610 may be sufficient to get approved. Every lender has its own eligibility requirements.

Make sure to research different lenders to see if you meet their loan requirements. To find out if you qualify for a traditional personal loan, start by reviewing your credit score and credit report. Even if your score was previously too low, it's worth assessing if anything has changed. You can review your credit report for free at AnnualCreditReport.com.

No-interest credit cards

Many credit card companies offer a no-interest introductory promotional period for new cardholders. Depending on the card and the offer, you may be able to pay no interest on your credit card balance for anywhere from 6 – 21 months. This can be a good option to cover a financial emergency or large purchase, as you can pay it off with no interest.

Keep in mind that credit cards generally have high interest rates. If you can't repay the card balance within the promotional period, you risk paying 20% or more on the remaining balance.

To ensure you can pay off the full balance before the introductory interest rate expires, divide your total balance by the number of months in the promotional period. If possible, pay at least that much each month.

Home equity loans or HELOCs

If you're a homeowner, a home equity loan or home equity line of credit allows you to borrow your home equity as a second mortgage. Because the debt is secured by the value of your home, home equity loans and HELOCs often have a lower interest rate than personal loans.

A home equity loan works like a personal loan. You borrow a lump sum and repay it in installments with a fixed interest rate. A HELOC works more like a credit card. You have access to a line of credit that you can draw from as you need it.

Keep in mind that because home equity loans and HELOCs are secured loans, you risk losing your home if you can't repay what you borrow.

Rocket Mortgage® offers home equity loans but not HELOCs.

Family loans

If you're unable to qualify for a traditional personal loan, consider borrowing directly from a family member or friend. Unlike a loan from a bank, there's no minimum credit score or eligibility requirements. You and your loved one can work out the details together, including how long you'll take to repay the loan and whether you'll pay interest.

Of course, family loans have some downsides. They can put stress on your relationship, especially if you can't repay the loan. Even though the deal is within the family, it's essential to draft a contract so that both parties understand the terms, obligations, and expectations.

FAQ

Here are answers to common questions about income-based loans.

Can I get a loan based solely on my income?

Yes. Income-based loans are approved based on the borrower's income instead of their credit history. You'll be expected to provide proof of your income in the form of pay stubs, bank statements, tax returns, and employer verification. Self-employed applicants may be required to provide additional documentation, such as a profit-and-loss statement and benefit statements.

Do banks give loans based on income?

Yes. Traditional banks may offer installment loans based on income, particularly if you’re a longtime client. Visit or call your local branch to discuss your income-based options.

How can I get a loan with no job or income?

If you don’t have a job, lenders may consider other forms of income, including:

• Unemployment benefits
• Retirement funds and pensions
• Social Security
• Disability benefits
• Alimony and child support
• Interest and dividend payments
• Passive income in various forms

If you have enough money regularly coming in, you could qualify for an income-based loan.

The bottom line: Assess the risks and benefits of income-based loans

An income-based loan can be a solid alternative if your credit score isn’t high enough to qualify for a traditional personal loan. But it’s important to understand the pros and cons of these loans and avoid predatory loans. Make sure to assess your loan eligibility and check your credit score. You may be surprised to learn you can qualify for a traditional personal loan.

Are you ready to apply for a loan? Explore your borrowing options through Rocket Loans℠ today.