High-Risk Loans Explained
High-risk loans are special types of credit products or financing that have a high likelihood of default compared to other forms of financing. This higher level of default is typically attributed to the easier loan evaluation process of the high-risk lenders. Essentially, they take various factors into consideration when approving a borrower, however, they are more lenient with approving borrowers without a strong credit history. The following factors are considered when applying for any type of financing:
Your Ability To Repay (Income) - It doesn't make any sense for a lender to give you any money unless they know that you can physically repay them. For this reason, they'll ask for income verification through paystubs or tax returns. Each borrower will have a set percentage of income to debt that you must exceed before getting approved for the loan.
Your Assets - In the event that you can't repay your loan, the lenders want to know that you have security they can take as collateral. This security is tangible assets like a car or home. In the event you don't pay back the loan for your car, they'll have the option to repossess the vehicle to recuperate their financial losses from the loan.
Past History Of Repayment - Your credit history and score are going to play a big part in your approval odds with any particular lender. They want to know that you are able to repay your debts on time and in full. If you've been late or defaulted on financial commitments in the past, it's likely that you'll do the same in the future.
Co-Signer - In the event that you have poor credit, a lender may require a co-signer. The co-signer typically has a stronger credit profile than the borrower, which helps to reduce the risks from the lender. The co-signer essentially agrees to pay back the loan in the event the borrower doesn't do so.
The Various Types Of High-Risk Loans
You should have a clear idea of what is considered a high-risk loan at this point. To help you get a better grasp of what these loans look like in real life, we're going to discuss specific examples. We'll go through what the type of loan is and the specifics that make it considered a high-risk loan compared to a conventional loan.
No Income Verification Loans
No income verification loans or no document loans are considered one of the riskiest loans out there. The lender will not require any sort of income verification from the borrower. They're solely relying on the borrower's credit history and assets to make a decision about whether or not to lend. These loans are typically used for those who are self-employed and have difficulty showing their income via tax returns and paystubs.
Unsecured Loans / Lines Of Credit
To start this one off, we're going to recap the difference between a loan and line of credit. A loan is a set amount of money that you borrow. Loans come with a fixed term length, say five years, and a fixed payment amount, say $200 per month. A line of credit is more like a credit card. You're given a set amount of money that you can borrow, such as $5,000. You can borrower up to that amount of money at any time. So, you can borrow $2,000 today and then, an additional $1,000 tomorrow. Your monthly payment will go up as you borrow more money. You essentially use your line of credit like a credit card by paying back what you owe and charging as you wish up to your limit.
Unsecured loans or lines of credit is when the lender doesn't require any form of collateral in exchange for the funds. It's easiest to understand what these mean by comparing unsecured and secured loans together. Think of a secured loan as a vehicle loan. You get a $20,000 car loan from your lender and, in return, you agree that the bank can use your vehicle as collateral for the loan. That means that, if at any time you stop paying on your loan, the lender can repossess the vehicle and sell it to get the funds that you still owe them for the loan. With an unsecured loan, there is no collateral that you're putting up. Unsecured loans are based on your word to the lender that you'll repay according to your repayment schedule.
High-Risk Means High-Interest And Fees
It's important to think about high-risk loans from the perspective of a lender. If you're lending out money to people, are you going to give your money to the people who have shown they can pay their bills on time or are you going to give it to people that have defaulted on their bills in the past and might be a high-risk borrower? The answer is pretty much obvious for most of us. We'd stick to the safe bet of the people who have strong past records of paying back their debts.
Lenders also know that the people who have a bad history of paying back their loans still need to get funding from time to time. So, to service this market, they will take on higher risk loans with people who don't have a strong payment history. Since the lender is taking on more risk, they require higher fees to help offset any losses they incur from funding the loan. These higher prices are typically seen in the form of higher interest rates and higher fees for applications, loan set ups, late payments, and so forth. At the end of the day, it pays to be level-headed and make financial decisions that are going to be best for you in the long run.