The signs are everywhere: “Bad Credit? No Credit? No Problem!”. The commercials run consistently on television and radio. It must be OK to get an unsecured loan with poor credit, right? Wrong! Unsecured loans for poor credit borrowers is, to put it mildly, dangerous. In some cases it is disastrous. A bad credit history has a snowball effect on finances. Once there is a problem financially, having to pay more for a loan just adds any problems.

There are two different types of loans; unsecured and secured. A secured loan is backed by collateral of some amount and an unsecured loan is backed only by signature. That’s why it’s often called a signature loan.

Because secured loans are backed by collateral that can be used if the loan defaults, the interest rate on them is very low. There are all kinds of collateral that can be used. An equity loan is a type of secured loan, but other collateral is certificates of deposits, cars, homes, land and stocks and bonds.

An unsecured loan is based on a borrowers income, debt to income ratio and FICO score. The FICO score is a consists of a compilation of your credit history including payment history, DTI ratio, total debt, how many credit accounts you have open and many other types of credit information. Because there is no collateral the interest rate is very high, even for good credit borrowers. The amounts are various, but for unsecured loans for poor credit the interest rate is the highest possible. Poor credit unsecured loans can be as high as 24-30% interest rates and the amounts lent are generally very low; like $500-$1000. The terms of the loan aren’t very attractive either.

Many poor credit loan lenders say you must have payment insurance (insurance in case you cannot pay back the loan). The insurance cost can be astronomical; usually between 20-30% of the loan amount. What the lenders don’t tell you is that loan insurance is optional. While payment insurance can be a good thing, it also is unnecessary for many people.

An unsecured loan can be a disaster for your credit history if even one payment is missed. The late payment will usually have a large penalty fee which can further put the borrower in debt. The effect works like a snowball. The first payment is late, the fee tacked on so the second payment is even bigger and goes unpaid, or partially paid, incurring yet another fee and so on.

What an unsecured loan for poor credit can be good for is rebuilding credit. In those cases, the best option is to get an amount as low as possible and use it only to rebuild credit over a period of a year or so. This means make timely payments on the loan and then, once the loan is paid off, close the account.

An even better option would be to use a secured loan to do the same thing. In this case a deposit is sent to a lender and the money is held as collateral for a credit card. The credit card can be used over and over again and paid off monthly. Be sure that the lender reports to all credit agencies and that there aren’t unusually high fees associated with the card. At some lenders a card is initially charged the entire credit limit in fees. The borrower must then pay off those fees to begin using the card. Avoid these lenders at all cost!

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