When your credit score is at or below about 620 points, it may seem like your only option for getting a personal loan is to pay an above-average interest rate. However, this isn't always true. While the lender you choose is important in determining whether you qualify, your level of perceived risk determines the interest rate. The trick to qualifying for a lower interest rate with a personal loan is to reduce your risk profile.
How Do Financial Institutions Determine Interest Rates?
It pays to shop around when looking for a personal loan, because banks have the authority to set their own credit requirements and rates. Most base interest rate decisions on the likelihood that a borrower will default. The prime rate is the interest rate a financial institution assigns to the customers it decides are least likely to default on a loan. As the perceived likelihood of default increases, so does the interest rate. This is why a borrower with good credit may qualify for a 4 to 6 percent interest rate, while borrowers with bad credit may pay 15 percent interest for a loan of the same amount.
Leverage Your Assets and Savings
Use a paid asset, the equity in an unpaid asset or money in a certificate of deposit or savings account as collateral to reduce the level of risk you represent -- and to reduce your interest rate. With a secured loan, it's the asset rather than your word that a lender relies on as a promise to pay. With a secured loan, the lender will typically limit the loan to about 80 percent of the asset's value or equity. You could lose the asset if you fail to pay on the loan.
Use a Nontraditional Option
Instead of borrowing from a bank or a payday lender, consider an online nontraditional option called peer-to-peer lending. P2P lending takes place over the Internet, and you borrow from a person rather than a bank. Although P2P lenders such as the Lending Club and Prosper charge an upfront fee -- typically a percentage of the amount you request -- interest rates can be lower than with other types of personal loans. Both sites have a rate-checking tool that can tell you what your interest rate will be before you apply.
Find a Co-signer
Having a co-signer with a good credit score, such as above 700, can reduce your interest rate. With a co-signer, the lender relies on the credit score of the person with better credit. In addition to paying less interest, you may also qualify for a larger loan. Both you and the co-signer are equally responsible for such loans, and even one late payment can damage your co-signer's credit score.
- Credit.org: What Is a Good Credit Score?
- Debt.org: How to Get a Loan With Bad Credit
- NetCredit: How Do Banks and Lenders Set Interest Rates?
- GreenPath Debt Solutions: Secured vs. Unsecured Loans
- LendingMemo: 7 Reasons Why a P2P Loan is Good News for “Bad” Credit
- Lending Club: Personal Loans
- Prosper: Borrow