Are Second Chance Loans For You?
Do you think a second chance loan will answer your financial worries? Perhaps so, but if you can't afford another mark on your credit history, find out all you can about second chance loans before you make a final decision.
What Is A Second Chance Loan?
Second chance loans are geared toward borrowers with a problematic credit history. This type of lending falls into the subprime category which was at the heart of much controversy when the economy plunged in 2008.
SEE ALSO: Bad Credit Personal Loans
Borrowers with bad credit are considered high-risk. 2nd chance loans are considered subprime because lenders cover that risk by charging higher than normal interest rates. Because interest rates are so high, second chance loans are considered short-term solutions. For a second chance loan to work to a borrower's advantage, it has to go something like this:
- A borrower makes timely payments.
- As payments are made on time, with no delinquencies, credit is rebuilt.
- When credit is rebuilt, a borrower can refinance at more agreeable terms.
Sounds easy enough, yes? It can work that way if everything goes smoothly but, unfortunately, things don't always go that way. It often takes years to rebuild credit, and the borrower can incur many risks during that time.
Who Can Qualify For A Second Chance Loan?
Second chance loans are marketed to those who have no credit or bad credit. When you apply you will typically need little more than proof of identity, proof of income, and your credit score. Depending on the lender, you may also need a co-signer.
Although each institution or private second chance loan lenders will have their own restrictions, the typical candidate for a second chance loan will have some or all the following characteristics:
- Declared bankruptcy
- Bad Credit Score
- Never Borrowed from a Bank Before
- Turned Down by Other Lenders
Case In Point
A woman from Texas is a perfect example of somebody who benefited from a second chance loan. She is a single mother who worked as a private nurse when she became very sick. She lost her job.
At the time, she was saddled with a mortgage, student loans, and an auto loan. She found that, with a severe illness, two children, and no money coming in, everything began to unravel quickly.
Within a year she had used her savings, borrowed all she could from family and friends, was facing foreclosure on her home and repossession of her car. All of this was happening just as Laura was recovering her health, but it was too late.
Luckily, she found another job, which paid well. With proof of employment, she was able to take advantage of a second chance mortgage program. She then took advantage of a second chance car loans program.
While making the payments was a real struggle, she knew that paying the extra interest for the short-haul was worth it to keep a roof over her family's head.
Now, five years down the road, she has rebuilt her credit enough to refinance her loans into more favorable terms.
What Are The Different Types Of Second Chance Loans?
Secured second chance loans involve some type of collateral. Typically, that collateral is a home or a car. If the borrower does not repay the loan or even if the borrower misses a single payment, depending on your contractual agreement with your lender, the collateral can be foreclosed or repossessed by the lender.
One benefit in having a secured second chance loan is that, while the interest rate is still higher than a traditional loan, it is lower than other types of second chance loans.
Getting approved for cash loans is not likely even after an indepth credit check without collateral.
An unsecured second chance loan does not require collateral or guarantee of any kind and is based solely on the credit history of the individual.
Interest rates on unsecured second chance loans are higher than secured loans. This type of interest rate is never good, but the better the credit history, the better the interest rate.
Beyond secured and unsecured, what are the specific types of second chance loans?
- Second Chance Personal Loans - If you need a second chance loan that will be used for personal reasons or for a short period of time, that is sometimes possible. The interest rates on this type of loan are often the highest of all. You must proceed with caution when selecting a trustworthy lender. There are many lenders online or so-called 'Pay-Day' lenders who will offer this type of loan. Read the fine print carefully.
- Second Chance Auto Loans - If home mortgages were the main focus of the subprime market in 2006 - 2008, auto loans seem to be the hotbed now. Zachary Karabell at Slate points out that, "more than a quarter of all auto financing [are] classified as subprime."
- Second Chance Home Loans - There are also some government-backed loans, which are available now through FHA, which are proving interesting for some second chance loan candidates. It's called the Back to Work program. If your home was foreclosed, or you lost it in a short sale, you would typically have to wait 36-months before you could apply for an FHA fixed-rate mortgage but with the Back to Work program you can now apply in 12-months, blog.credit.com explains.
Where Do You Get A Second Chance Loan?
You can apply for second chance loans from a variety of lenders depending upon the type of loan you need. If you need an unsecured second chance loan, your choices are limited somewhat more, and your interest rates will be higher.
- Credit Unions
- Private Lenders
What Are The Risks?
While lenders protect themselves from second chance loans by charging high-interest rates, it really is more complicated than that.
As seen in 2008 onward, lenders didn't fare well either when the subprime market came crashing down. But there is at least that primary line of defense there to protect them.
With the borrower, there is very little in the way of protection and there are some very real risks involved.
- If a lender is no longer able to refinance a loan, a borrower might be faced with payment shock when the balance of the loan becomes due at once.
- Paying interest only means that a borrower will often pay thousands more over the course of a loan.
- Second chance loans are often accompanied by other high fees and penalties such as fines for prepayment.
- Adjustable-rate loans should be noted carefully because monthly payments can drastically increase according to varying interest rates.
- Often the low-monthly payments entice borrowers to take on more than one second chance loan and they find themselves overwhelmed and unable to make payments.
- Inability to meet payments and inability to refinance because of prepayment penalties means a high default rate.
- Some second chance loans come with balloon maturities that come with a very large final payment.
- Background checking is sometimes ongoing and terms might change if a lender deems you to be at a higher risk. However, this will be outlined in the terms of your loan.
- Although interest rates are high, payments are typically low, and you can rebuild our credit.
- It is the only way that some people will be able to get on the property ladder and eventually own their homes.
- It relieves some of the stress to the borrower and a sense of being trapped by debt, allowing them to live a happier more productive life which in turn should allow them to be more productive in their jobs, thus allowing them to pay their bills more readily.
- High-interest rates mean borrowers pay thousands extra over the life of a loan.
- Often accompanied by high fees and penalties for prepayment, disallowing early payment of loan.
- Borrower lulled into a false sense of financial security and continues to over-extend credit until forced into another dire financial situation.
- High default rate.
The Second Chance Bottom Line
While second chance loans may be the only prospect for some borrowers, it is definitely borrower beware.
If you don't plan to rigorously stick to the repayment schedule, if you aren't prepared to buckle down and live with the high-interest rates, this option isn't for you.
You need to read the fine print very carefully. The main point of a second chance loan is to rebuild your credit. Sure, you will pay the penalty of a higher interest rate while you're doing that but the idea is that, as soon as possible, you refinance into more agreeable terms.
If you have a second chance loan that charges an astronomical fee for prepayment, thus making refinancing cost-prohibitive, it's yet another reason to think again before signing on the dotted line.