Interest rates can vary from one loan to another and will largely depend on a borrower’s financial history. For example, bad credit loans will likely have higher interest rates than good credit loans.1
To understand how a bad credit score affects your interest rate, you first need to know the different types of interest that exist, how lenders determine interest rates, and how they impact the cost of your loan. Continue reading to learn more about interest rates on bad credit loan options and other loans in general.
Different Types of Interest Rates
The different types of interest can have different impacts on any loan you receive. By understanding the various types of loans, you will appreciate what happens to the cost of a bad credit loan when the interest rate is affected by a bad credit score.
Fixed Interest
Fixed rate loans will not fluctuate during the term of your loan. It is the most common form of interest.2 Fixed interest is easy to calculate, easy to understand, and stable.
Variable Interest
Unlike fixed interest, variable interest fluctuates and is usually tied to the movement of base interest rates. Borrowers can benefit if the variable rate declines but end up paying more if it rises.
Annual Percentage Rate (APR)
The annual percentage rate reflects the total cost of your loan, which includes the interest rate and relevant fees.
The Prime Rate
Favored customers receive the prime rate from banks for loans. It’s relatively lower than normal interest rates and is tied to the U.S. federal funds rate (the rate banks use when borrowing and lending to each other).
Simple Interest
Simple interest has a basic structure. It’s calculated using a simple formula: principal x interest rate x number of years = interest.
Compound Interest
Unlike simple interest, which is calculated only on the principal, compound interest is calculated on both the principal and interest. It is calculated annually, and the interest amount is added to the loan balance, which is then used to calculate the next year’s interest.
Accountants refer to compound interest as “interest on interest” of a credit account or loan balance. An increase in this form of interest can have a greater impact on your loan compared to simple interest.
Now that you know the types of interest, here’s how your credit score is used in determining the interest rate on your loan. The pricing model lenders use to achieve this interest is the credit-scoring system and risk-based pricing.
The Credit-Scoring System and Risk-Based Pricing
Since the risk of a loan varies based on borrowers and other aspects of the loan, these two factors play a role in the pricing of loans, including the interest rate. Credit scoring systems, which were developed more than fifty years ago, offer a solution for assessing potential borrowers.
Lenders use sophisticated computer programs that assess borrowers and underwrite consumer credit—like credit cards, mortgages, small business lines of credit, and home equity loans.
Credit scoring helps determine interest rates charged to potential borrowers and is commonly referred to as risk-based pricing, which helps lenders offer competitive prices on loans across many borrower groups. In this system, borrowers with good credit scores receive reduced prices on loans, while those with bad credit scores pay higher prices.
Here is how your credit score can affect the interest rate on different types of loans:
Auto Loan Interest Rate
Based on the current auto interest rates on auto loans, if you have good credit, you can expect a rate closer to 4%, with poor credit, you will likely receive an interest rate closer to 16% or more.3
Here is a general breakdown of the interest rates you can expect based on your credit score3:
| Credit scores | Average APR for used cars | Average APR for new cars |
| 781 – 850 | 4.69% | 4.19% |
| 661 – 780 | 6.38% | 5.01% |
| 601 – 660 | 10.91% | 7.91% |
| 501 – 600 | 16.78% | 12.17% |
However, the interest rate can vary based on other factors besides your credit score, including:
- The term length of your loan
- Whether the car is new or used
The average auto loan interest rate in 2019 for a new car was 4.23% for borrowers with a credit score of 750+.4
Car buyers with a high credit score can even get interest rates as low as 2%, showing just how crucial this score is in determining auto loan interest rates. This is further demonstrated in the fact that borrowers who have lower scores can receive five to ten times the interest rate of those with the best credit.
Small Business Loan Interest Rate
For small business loans, interest rates will vary significantly based on credit scores, and lenders may not offer loans to borrowers with bad credit. Borrowers with excellent credit scores can receive interest rates as low as 3%, and borrowers with poor credit can receive a 5.5% interest rate.5
Online lenders are more accessible to people with bad credit. Interest rates and loan terms vary based on the lender and loan products.
To appreciate the high-interest rates that borrowers with bad credit receive compared to those with good credit, here is a sample of the rates that good credit borrowers might receive5:
| Lender type | Average annual interest rate |
| Large national bank | 2.55% – 5.14% |
| Small national and regional bank | 3.23% – 5.40% |
| U.S. branches of foreign banks | 1.50% – 5.45% |
| Online/ alternative lenders | 5.49% – 66.57% |
In contrast, here is an example of the interest rate variation that different lenders and different products will typically have based on borrowers with varying credit scores5.
| Loan product | Average annual percentage rate for good credit borrowers | Average annual percentage rate for bad credit borrowers |
| Bank loan | 4.25% | 13.00% |
| SBA 7(a) Loan | 5.85% | 9.00% |
| Online term loan | 7.35% | 99.70% |
| Line of credit | 5.25% | 80.00% |
| Merchant cash advance | 12.00% | 200.00% |
| Invoice factoring | 13.00% | 60.00% |
Personal Loan Interest Rate
Personal loan interest rates vary greatly based on your credit score, especially for unsecured loans, which rely more on your credit score than secured loans. Here are some averages.6
- Borrowers with credit scores between 720 and 850 can expect an average personal loan interest rate of 9.8%.
- Borrowers with credit scores between 690 and 719 might receive an interest rate of 15%.
- Borrowers with scores between 630 and 689 may receive a 21.3% interest rate.
- Finally, borrowers with low credit, between 300 and 629, can get a 28.2% interest rate or higher.
Fortunately, many loan lenders usually offer funding access to people with bad credit.
Mortgage Interest Rate
Interest rates on mortgages also vary based on the borrower’s credit. Those who receive the lowest rates have a credit score of 760 or higher. With a poor credit score, you will not only receive a higher interest rate but also pay a more substantial down payment.
For Federal Housing Administration (FHA) loans, first-time buyers with a credit score of 580 or higher qualify for a 3.5% down payment. If your credit score is 580 or lower, you will need a 10% down payment.
Understanding Bad Credit Loans and How to Navigate Them
Now that you know more about interest rates, it may be helpful to get a better understanding of bad credit loans. For many, understanding the intricacies of financial lending can be overwhelming, especially when poor credit is involved. Fortunately, despite having a bad credit score, numerous financial solutions exist. Below is more information on navigation bad credit loans:
What Are Bad Credit Loans?
Bad credit loans are primarily designed for individuals with low credit. Not all banks and credit unions offer these bad credit loan options, but online lenders often specialize in loans for bad credit.
When reviewing applications for a bad credit loan, lenders typically consider your credit history. However, if you have a poor credit report, they might focus more on your current financial situation and ability to make monthly payments for your bad credit loan.
There are two main types of bad credit loans: unsecured and secured loans.
Secured vs. Unsecured Loans
A secured loan requires collateral like a home or car. If you default on the loan, the lender has the right to claim your asset.
Unsecured loans don’t require collateral. One example is a personal loan. Given the higher risk involved, they might carry a higher interest rate. However, this is not always the case. An unsecured personal loan is a typical example. While getting an unsecured loan with bad credit might be more challenging, some specialized personal loan lenders might consider other factors beyond your credit.
Personal Loans for Bad Credit and Debt Consolidation
Bad credit personal loans can be used for various purposes, including debt consolidation. By consolidating your debt, you combine multiple debts into a single monthly payment, possibly with a lower interest rate. Personal loans are not the only option; there are other ways to consolidate debt. For example, you can use a credit card to pay off personal loan options.
Factors to Consider With Bad Credit Loans
- Interest Rate — This should be one of your primary considerations with loans for bad credit.
- Origination Fee — An origination fee is a one-time fee charged by the lender when initiating a loan. Always factor an origination fee into the total cost of the loan. Most lenders charge an origination fee of some sort!
- Loan Agreement — Ensure you understand the terms, including penalties for missed payments.
- Loan Funds — Know how and when you will receive the loan funds, especially if you need them for urgent expenses.
- Monthly Payments — Ensure you can manage the monthly payment amount. Some lenders might offer flexibility in monthly payment structures.
Bad Credit Loans And Other Alternatives
- Payday Loans — Payday loans are short-term loans that are typically due on your next payday. Payday loans might seem attractive but often come with exorbitant interest rates.
- Credit Unions — Credit unions often offer more favorable terms than banks. Even if you have low credit, a credit union might provide you with a loan based on other factors.
- Online Lenders — With the rise of technology, online lenders have become a popular choice. They might offer more lenient criteria compared to traditional banks, especially for bad credit borrowers.
- Personal Loans — There are several kinds of personal loans, there may be possible options such as bad credit personal loan options (loans for bad credit) and personal loans that have collateral—called secured personal loans. Overall, a personal loan can be extremely versatile and flexible. The best personal loans have flexibility and competitive interest.
Improving Your Chances for Approval for a Loan With Bad Credit
- Minimum Credit Score — Some lenders specify a minimum credit score. Knowing this upfront can save time and potential disappointment. In most cases, lenders can vary quite a bit with their minimum credit score.
- Show All Your Sources of Income — Make sure to show all your income sources for the best chances of approval.
- Offer Collateral — If possible, consider a secured loan if you cannot meet a minimum credit score. Offering collateral can make you a less risky borrower.
- Consider a Co-signer — Having someone with a better score co-sign can improve your chances of approval.
FAQs
Bad credit refers to a low credit score, typically resulting from a history of missed payments, high credit card balances, or other negative credit behaviors. Lenders view individuals with bad credit as higher-risk borrowers.
Various factors can lead to bad credit, including late or missed payments, high credit utilization, bankruptcy, foreclosure, and defaults on loans such as a personal loan option. Unforeseen life events such as job loss or medical emergencies can also contribute.
Strategies to improve credit include paying bills on time, reducing credit card balances, disputing errors on reports, diversifying credit types, and avoiding new credit applications.
These reports are comprehensive summaries of an individual’s credit history, including credit accounts, payment history, and inquiries. Understanding these reports is vital for monitoring credit health and identifying inaccuracies.
Credit repair services offer assistance in improving credit. These services often provide guidance on managing credit and working toward better financial health.
Individuals with bad credit often have access to credit cards designed to help rebuild credit. These cards may have higher interest rates and lower credit limits but provide an opportunity to demonstrate responsible credit use.
Credit building involves responsible credit management, such as paying bills on time, keeping credit card balances low, diversifying credit types, and refraining from opening too many new accounts.
CreditNinja’s Thoughts on Interest Rates
As you can see, low credit will affect the interest rate on every loan option available. In some cases, you may not receive financial assistance if your credit is too low.
At CreditNinja, we want you to know that understanding the impact your score has on each loan is essential to help you select the best loans that offer the best value.
References:
- The Cost of Bad Credit & Poor Credit | Working Credit NFP
- 7 Types of Interest Rates You Need to Know | Yahoo.com
- Auto Loan Rates & Financing in August 2023 | Bankrate
- Average Auto Loan Rates in August 2023 | U.S. News
- SBA Loan Rates 2023 | NerdWallet
- Best Personal Loan Rates for August 2023 | Bankrate
