How Do I Get Out of Debt with Bad Credit?

Bad credit can cost you thousands of dollars in credit card interest, and on auto and home loans. It can also prevent you from qualifying for debt relief options like low-interest debt consolidation. The good news is there are debt relief options like nonprofit debt management available to people with bad credit.

Choose Your Debt Amount

How to Get out of Debt When You Have Bad Credit

Bad credit and too much debt are a vicious circle. Bad credit happens when debt gets out of hand, and you have trouble making payments. But it can be tough to get out of debt when you have no money and bad credit.

The best options to reduce or get out of debt if you have bad credit won’t cost a lot in interest and fees and will not generate more debt. In some cases, they can also improve your credit.

There are many ways to reduce debt, including debt consolidation loans, debt management plans, nonprofit debt settlement, for-profit debt settlement, credit card balance transfers and more. Not everyone’s financial situation is the same, which means that what option is best won’t be either.

You’re likely already familiar with the consequences of bad credit – high interest rates on credit cards, auto and home loans, higher deposits for housing and utilities and more. Those challenges can lead to even more debt as you try to keep your head above water.

Now it’s time to become familiar with how to turn that around.

Obtaining Debt Relief with Bad Credit

To get rid of debt, particularly if you have bad credit and little money, there are some steps you can take that won’t cost anything. There are also some good options, as well as ones that aren’t so good.

No Cost Steps to Reduce Debt

Get control of your finances with a budget and expense-cutting. It’s not glamorous, but it’s a required first step. Put aside money to pay your bills on time. Cut expenses that are not necessary. No debt reduction solution will work without taking this step and you may see an improvement in your credit score as you make payments on time.

Contact your bank or credit union. If you have a checking or savings account, you have a relationship with a bank or credit union. They may be willing to offer a debt consolidation loan or a personal loan. Make sure that the interest is low enough to make sense. If you don’t belong to a credit union, consider joining one. They are nonprofit, so have lower fees and interest.

Borrow from family or friends. This can be a very good option or a very bad one, depending on your circumstances. A family member or friend may charge no interest and be flexible about repayment. On the other hand, emotional and relationship issues that won’t surface when you borrow from a traditional lender may cause issues you didn’t anticipate. If you choose this option, put the terms in writing, stick to the terms and don’t miss payments.

Best Debt Consolidation Options

There are some debt reduction options that work the best for people with no money and credit that ranges from fair to bad. Those options include:

Debt Management Program. Nonprofit credit counseling agencies can help you put together a budget, and discuss options, including a debt management plan. This is not a loan, but a program that will reduce your interest rates and lower your monthly payments while also offering credit counseling that should help you long term.

Debt consolidation loans – Banks and credit unions offer personal loans that generally have lower interest than credit card debt.

Debt settlement – This program allows you to pay less than what is owed to settle a debt, but among the consequences are seven years of negative impact on your credit.

Peer-to-peer lending – Peer-to-peer lending matches applicants online to investors who are willing to take a risk. The good news is, standards may be lower than a traditional lender. While there are online lenders that allow credit scores as low as 580 – like Upstart, Prosper, Avant and First Financial – interest rates can be as high as 30-35%, which means you’d just be shifting high-interest debt around rather than solving the problem.

Options That Require Better Credit

Credit Card Balance Transfer. Some credit cards offer an introductory zero percent interest rate to transfer high-interest credit card debt. This is a good option if your credit is still good enough to qualify and if you can pay the card down before the introductory period is over, when the interest rate will increase.

Home equity loan. If you have owned your home for several years, you can borrow against the equity – the difference in its value and what you still owe. Interest rates are low, similar to what mortgage rates are. Lenders have qualifying standards, and if your credit is bad, you may not be able to get the loan even if you have equity.

Bad Options

Payday Loans. While these high-risk loans may look quick, easy and tempting, they are not an option for paying off debt, no matter what your credit. Interest rates for these loans are generally 399%, compared to the 25%-30% you pay on credit cards. This option should not even be considered.

What is the Best Loan Option with Bad Credit?

There is no “best” option for everyone, and you must weigh your own financial situation when trying to determine what type of loan will be best to pay off your debt.

Debt consolidation loans are personal loans, paid back in installments for a predetermined term, usually 12-60 months. If this option is right for you, the next step is to choose a lender. Shop around for a lender that will offer you the lowest possible interest and the best terms. Again, be sure to do the math and determine that the debt consolidation loan will be a financial benefit, not a financial disaster. Don’t look at the amount you are borrowing as the amount you will pay. Instead, look at the monthly payments, interest, how much you will pay over the term of the loan.

Since a debt consolidation loan is unsecured debt, meaning the loan is not backed by collateral, if you default, a lien could be placed on your wages or property.

The safest loans come from banks, credit unions and peer-to-peer lenders that offer debt consolidation loans. But again, if you have bad credit, you may not qualify, or the interest rate will be too high to make it worthwhile.

Loans from family members, home-equity loans and credit card balance transfers can be good avenues, but only if you are totally committed to repayment. Failure to repay those sources could mean destroying a close relationship with family or friends; foreclosure on your home or seeing interest rates soar on your credit cards.

Debt Management Plans

A debt management plan through a nonprofit credit counseling agency, like InCharge Debt Solutions, is not a loan. Counselors at the agency work with creditors to get better terms on your debt, including lower interest rate. You make a monthly fixed payment to the agency over the 3-5 years of the plan, and the agency distributes the money to your creditors. Your credit scores is not a factor in qualifying.

DMPs may have an initial negative impact on credit score, but as payments are made, your credit score should improve and your debt will be paid down. The plans don’t appear on your credit report.

Nonprofit Debt Settlement

Nonprofit debt settlement can result in credit card debt forgiveness for 40%-50% of the balance. With the program – including InCharge Debt Solutions’ Less Than Full Balance Plan – you pay 50-60% of your balance in fixed payments over 36 months, then the rest is forgiven.

There is also for-profit debt settlement, where the goal is to have 50% of your balance forgive. However, that figure comes from negotiations and the lenders do not have to agree to any settlement. There also are fees involved and the total savings is likely to be closer to 25%. For-profit debt settlement can lower your credit score even more because creditors aren’t paid the full amount.

With both, you will have to pay income tax on the forgiven portion of the balance.

What Happens When You Have Bad Credit?

“Bad credit” means that lenders see you as a high risk to lend money to. Specifically, it means that you’ve probably borrowed too much money and had trouble paying it back, including payments that were 90 days late or more.

Lenders want to know if you’re likely to pay them back. Your credit score and the credit report that shows your history of borrowing and payments, is how they make that determination. The lower your score, the worse your credit.

The impact of bad credit on you is that it’s more difficult to get loans or credit cards with affordable interest rates. It can keep you from buying a car or a house, or even renting an apartment or getting a job, since some employers do credit checks on potential employees. If you can get a loan or credit cards, the interest is often very high, which usually compounds the problem.

Risk-Based Pricing

Risk-based pricing is when lenders adjust interest rates by estimating the risk to them of the borrower not paying the loan back. Someone with bad credit is considered a high risk, and therefore their loan has a high interest rate. A low-risk borrower receives the lowest interest rates.

Every lender has its own formula for calculating risk, but most include credit score, outstanding debts, income, job status and debt-to-income ratio in arriving at the risk factor. Much of that information comes from your credit report.

If lenders gave you unfavorable terms on a loan and used your credit report in making their decision, you should receive a Risk-Based Pricing notice. If you receive one, you may contact the agency that supplied the credit report to verify that all the information in the report was accurate.

How to Get a Loan with Bad Credit

If you have bad credit and are looking for a way to reduce your debt, taking the time to improve your credit score will help. A better credit score can be the difference between being approved for a loan or rejected. It will also mean a lower interest rate, which, in turn, means lower monthly payments. Raising your credit score by 20-30 points can mean the difference between being a bad credit risk and a good one.

Working to raise your credit score has another advantage – it can also lower your debt because you’re making payments on time, decreasing credit utilization and more. So, when you do apply for a loan, it may end up borrowing a lower amount than what you initially thought it would be.

Monitoring and Improving Your Credit Score

Knowledge is power, and there’s no better weapon against bad credit and debt than understanding your own finances and figuring out where the problems are.

The best way to do that is to monitor your credit report.

Your credit report is available for free once a year from each of the three credit reporting bureaus Experian, Transunion and Equifax. It’s a good idea to get all three reports, since not all creditors report to all three.

You can receive a free report by visiting annualcreditreport.com or call or call 1-877-322-8228. It costs $9.95 to get your credit score from the bureaus, but many banks and credit card companies offer free weekly credit score monitoring to customers. There are also free online services that offer free credit scores, just search for “free credit score” online. Your credit card can change weekly as you use, and make payments on, credit cards.

“The first thing any lender wants to know is whether you’ve paid your credit accounts on time,” Can Arkali, principal scientist for analytics and scores at FICO, said. “That negative information has a considerable impact on your credit. The important thing to keep in mind is that the impact of negative payment information will be less damaging over time if you keep your credit obligations in good standing.”

The best ways to raise your credit score are:

Clean up your credit report: If there are errors or debts that aren’t yours on your credit report, you can write a dispute letter to creditors, collection agencies and reporting bureaus and have it fixed. You can also attach a note explaining a bad credit situation that shows on your report.

Make on-time payments. Your history of on-time payments is a major factor in determining your credit score. Set up automatic payments online to be sure you pay on time. Make the automatic payment for the minimum, if that’s all you can afford, then pay more separately when you can. You can make as many payments a month as you want.

Keep card balances low. Another factor that counts for 30% of your credit score is credit utilization – the amount of credit you have available vs. what you use. Try to pay as much as you can monthly to reduce your balance and don’t use credit cards unless necessary.

Don’t close unused credit card accounts. It’s great if you stop using a credit card, just don’t close the account. Keeping the card helps your credit score in two ways: it adds to the length of credit history and the zero balance also figures into your credit utilization ratio.

Make a monthly budget. Keep a budget, in whatever way you’re comfortable with. It can be in a notebook, through one of the several budget apps available, an online spreadsheet or something in between. Determine all your income for the month and how much you will pay for your bills. This helps you keep your monthly credit card and other payments on track. Review it monthly and adjust when possible so you can make more debt payments.

Contact a nonprofit credit counseling agency. This is often an overlooked advantage you get for FREE!. A credit counselor at an accredited nonprofit agency will review your financial situation and help you set up a budget that works with your financial situation. The counselor will also discuss debt payment options with you. This service costs nothing. Take advantage of it.

What Is Considered Bad Credit?

Different lenders have different standards for what bad credit is, and the number is more important than the label that goes with it.

The numbers come from two scoring companies, FICO and VantageScore. Both take into account payment history, credit use and limits, type of credit, age of credit and new accounts. Each scoring method gives slightly different weight to those categories. For instance, FICO considers payment history the most important factor, counting it as 35% of your credit score. Vantage considers “total credit use, balance, and available credit” to be “extremely influential,” while ranking payment history “moderately influential.” While the way they score may be slightly different, the action you can take to improve your score remains the same.

It is possible to get a debt consolidation loan with a low credit score, depending on the lender. If you take this approach, as mentioned earlier, keep an eye on what the interest will be and determine if the loan makes financial sense.

Lenders buy credit scores from FICO and VantageScore, and when you apply for a loan or credit card, you aren’t informed which one it will be.

The two scoring methods also have slightly different ranges for poor to excellent credit:

FICOVantage
Exceptional/Excellent800-850781-850
Very Good/Good740-799661-780
Good/Fair670-739601-660
Fair/Poor580-669500-600
Poor/Very Poor300-579300-499

Challenges of Bad Credit

There’s a saying “nothing costs money like being poor.” If you have bad credit and debt that you can’t seem to get out from under, you understand what that means.

Bad credit combined with debt creates a catch-22 – higher interest rates and fees can make things you need in life, like a car or place to live, more expensive. Or you may not qualify for a car loan at all – or a place to live.

Renting an apartment with bad credit can be difficult. Some landlords do credit searches on applicants to determine if they are a bad risk. They may not rent to you, or may require more upfront deposits or higher rent. Utility and cellphone companies often require larger deposits from people with bad credit. If you give them permission, employers may look at your credit report as part of the hiring process and may disregard your application because you have bad credit.

Insurance companies can also refuse to write car, home or life insurance policies because of bad credit. If they do approve a policy, it likely will be at a much higher rate.

If you can’t overcome the challenges of bad credit while trying to get rid of debt, it may be time to talk to a credit counselor at InCharge Debt Solutions. A counselor will help give you some perspective and help you create a strategy to improve your credit and reduce your debt.

The certified counselors at InCharge are trained to educate consumers on how to manage their money effectively and offer suggestions about the best options for eliminating debt. The options they’ll discuss may include anything from a debt management program, to debt consolidation loan or nonprofit debt settlement.

By law, the counselors at nonprofit agencies are required to offer advice that is in the client’s best interest. Call the credit counselors, or fill out the Get Started form, at InCharge Debt Solutions and statt on the path to turning around your bad credit and reducing your debt.

About The Author

Heather Eggers

Heather Eggers holds a Master of Science from East Tennessee State University’s College of Business and Technology, one of fewer than five percent of business schools worldwide accredited by AASCSB International. Like most millennials, she has a budget, bills, and some student loan debt to manage. She learned early to recognize the value of good financial advice. She also learned how to share, so Heather uses her digital communication and business background to share what she knows and learns as a contributing writer.

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