What Is a Bad Credit Loan?

When seeking a personal loan to fund a variety of expenditures, whether it be a mortgage, a medical bill or a car, most lenders will ask for a credit history. The rate that the lender issues the loan at depends largely on the strength of that credit history (amongst other variables). This credit history can be distilled into a three-digit number known as the credit score, which provides a relative evaluation of the borrower’s spending patterns and historical ability to repay debt.

Borrowers with higher credit scores are deemed to be more credit-worthy (less risky for lenders) and therefore enjoy privileges like lower rates and easier approvals for loans. However, what happens when a borrower does not have a solid credit score? While securing a personal loan from a banking institution at that point is an uphill task, there are special debt instruments known as bad credit loans offered by various lenders that fulfill this purpose.

How Is a Credit Score Determined?

In Canada, there are two main credit reporting agencies: TransUnion and Equifax. While these are both separate companies with their own algorithms used to determine the credit scores of borrowers, the variables used can broadly be distilled into the following categories: payment history (payments are made on time, no collections, etc.), outstanding debt, length of credit history, types of debt (credit cards, auto financing, etc.), number of credit inquiries on file.  

Credit Score Factors Explained

1. Payment History: This is arguably the single most important factor affecting credit scores as lenders ideally want to see a history of full outstanding repayments promptly. If the borrower has ever missed credit card payments or made late loan payments, the credit score gets negatively impacted.

2. Debt Outstanding: Most people carry some forms of debt, such as mortgages, student loans, credit cards, car loans etc. While having outstanding debt is normal, it is the volume of debt and length of time that it is held for that is gauged by reporting agencies i.e. borrowers with a large amount of debt month to month and/or use more than 30% to 40% of available credit limits will likely see lower scores.

3. Time: Simply put, lenders want to see a demonstrable history of credit use and timely repayment. The longer the borrower has had an open debt account and has been using it responsibly, the better the credit score.

4. Types of Debt: Borrowers who have just a credit card or a singular type of debt will likely have lower credit scores than borrowers who have multiple types of debt such as a credit card with a personal loan. This is attributable to lenders favouring borrowers who are responsible with multiple different types of credit.

5. New Inquiries: When lenders or credit card companies complete a hard credit pull, credit scores are adversely impacted. Hard pulls are when a company brings in the borrower’s entire credit report to evaluate and validate their creditworthiness. Therefore, applying for multiple different types of credit and/or loans within a short period of time is not favourable as it signals that the borrower is either being rejected or is using too much credit.

Once these variables are synthesized, a credit score is provided to the borrower. A credit score between 300 to 550 is generally considered to be poor wherein it becomes difficult to obtain certain types of debt, especially the ones that are issued by banks.

How Bad Credit Loans Work?

The bad credit loan itself is debt that is provided to a person with a score that falls short of the desired range of conventional banking institutions and loan providers. These are typically provided in a lump sum amount to borrowers with terms that can vary from a few months to up to 3 to 5 years. The amounts offered under these loans tend to be relatively smaller. This is largely due to the increased risk that lenders face with these types of loans. This risk is driven by two factors: (i) bad credit loans are unsecured i.e. not backed by a tangible asset such as a house in a mortgage or a car in an auto loan, (ii) when lending to borrowers of lower credit quality, there is an added risk of non-repayment as compared to other types of borrowers. To compensate for these risks, lenders charge a premium rate.

It is also important to note that the lending parameters for these types of loans are significantly simpler than other types of conventional loans. Lenders of bad credit loans do not do a hard credit pull and simply require ID, existing debt, and income verifications in most cases. This ensures that consumers that have a history of consumer proposals, credit counselling, restructuring, bankruptcies or other delinquencies can still apply and be successful in obtaining a bad credit loan. 

How Do I Qualify For a Bad Credit Loan?

Typical qualification requirements for a bad credit loan include steady income from full time or part time employment, being of age of majority in the province of residence, and no undischarged bankruptcy or consumer proposal on the borrower’s file. Other factors will be considered, and each application is reviewed on a case by case basis.

Required Documents to Provide

1. Proof of address and age: These documents serve to verify that the borrower is above 18 years of age and is a resident of Canada.

2. Existing Mortgages and Number of Dependents: This is to gain visibility into the borrower’s existing obligations. In most cases, mortgages are senior to all other types of debt meaning that if the borrower declares bankruptcy, mortgage providers get paid out first when assets are liquidated.

3. Proof of employment: Since bad credit loans largely tend to be unsecured, they are provided on the basis of the borrower’s cash flows. This means that it is important to provide employment information such as salary and length of time spent at the job.

Once the information has been provided, the lender will assess the overall credit profile and come up with a maximum lending amount, rate and loan term. If this proposed loan structure is agreeable to the borrower, he/she then has to sign the documentation and the loan principal amount will be deposited into their personal bank account. Thereafter, the borrower has to repay the principal and interest at periodic intervals as per the stipulated contract.

How does bad credit come about?

Simply put, bad credit is a function of one or more of the following:

To avoid detrimental hits to credit scores, it is important to be prudent with credit by only taking out loans that can be afforded based on monthly income. It is also critical to repay these loans on time to avoid late fees, which are an added consequence beyond the credit score impact.

Advantages of Bad Credit Loans

Drawbacks of Bad Credit Loans

There are, however, certain considerations that need to be evaluated before selecting the bad credit loan as a financing option. These include:

What The Numbers Say…

The chart below shows that nearly 50% of Canadians fall within the 700-799 credit score range. Also, over 25% of Canadians have a credit score below 699.

Bad Credit Loans Frequently Asked Questions

How Big of a Loan Can I Get Approved for with Bad Credit?

The funds received from bad credit loans are a function of the borrower’s income. Based on that, capacity to repay is calculated and a pre-approval amount is calculated. Typically, bad credit loans can be anywhere between $500 and $5,000, but can go higher.

Can I Receive a Bad Credit Loan with a Previous Bankruptcy on my Record?

Yes, most bad credit loan providers offer financing even to borrowers with previous delinquencies, bankruptcies and consumer proposals. However, if the bankruptcy or consumer proposal are open (not discharged), it will make it extremely difficult to get approved for any kind of credit, including bad credit loans. 

Do I Need a Downpayment for a Bad Credit Loan in Canada?

No, bad credit loan providers do not require any money to be put upfront.

What are the Consequences for Non-repayment of Bad Credit Loans?

Most bad credit loan providers have financial penalties in place, which can add up quickly. Therefore, it is important to stay prudent with borrowing amounts and repay loans on time.

What Interest Rates Should I expect for Bad Credit Loans in 2020?

You can expect worse rates if you are getting a bad credit loan in Canada, compared to borrowers with fair or good credit. Bad credit loan interest rates start at about 20% but can rise much higher.

If you can improve your credit score, you should be able to access loans starting at about 7%. Banks will usually reject borrowers with bad credit, while alternative lenders will issue the loans, but will charge higher interest rates. If your credit score falls into the “bad” category, you can expect the APR to be somewhere between 20% and 50%. Remember to read your contract carefully, and ask the lender questions to ensure you have full understanding of the cost of your loan, and repayment terms.

Will a Bank Give Me a Loan with Bad Credit in 2020?

The biggest banks in Canada have tightened their credit-issuing requirements. If you have bad credit, it will be difficult to get a loan from the big banks. In 2020, it is unlikely that getting a loan with bad credit will become any easier.

There are still many reputable lenders that will offer bad credit loans. The unfortunate reality is that the banks are not among these lenders. It may be worth a try applying at a few banks, but you will likely face multiple rejections if your credit score is too low.

Can I Trust Lenders Offering Bad Credit Loans with No Credit Check and Guaranteed Approval?

Generally speaking, you should be careful with bad credit personal loans in Canada with no credit check. There are some lenders who don’t check your credit and (almost) guarantee approval that are reputable.

If you want to find a lender that doesn’t check your credit score, go with a trusted option. The online world may contain dangerous loan-related scams, so you should be suspicious of lenders with unverifiable reputation. Legitimate lenders that offer guaranteed approval for bad credit loans will never ask you to pay upfront for a loan. They will also never ask you for personal information before you’ve sent an application.

If a lender doesn’t ask you any of the above and is an accredited, legitimate business, you won’t have any problems. With basic due diligence, finding a trustworthy lender is not difficult.