High-Risk Loans You Should Avoid

Written by: Kristyn Pilgrim
Updated: 8/14/20

Sometimes, federal student loans are not enough to cover the cost of education, so you may turn to private loans. However, be aware that payday, title, and personal loans can prey on individuals needing funds immediately, and they often come with a high level of risk. 

Introduction to Federal and Private Student Loans 

At CollegeFinance.com, we recommend that students first apply for federal student loans. However, if federal student loans don’t cover everything, you may need to seek additional funds through private loans. We’ll explain the differences between the two student loan types.  

Quick Guide to Federal Student Loans 

Federal student loans are designed for students in college or at career schools. You must apply for federal financial aid by submitting a Free Application for Federal Student Aid (FAFSA). Before taking out a federal student loan, you should consider the loan’s legal obligation. Once you receive a student loan, you will have to repay the amount you borrowed plus interest. 

Whether you are a parent, undergraduate student, or graduate or professional student, you will have different amounts of borrowing. An undergraduate student borrowing a Direct Subsidized Loan or a Direct Unsubsidized Loan can annually receive from $5,500 to $12,5000. A graduate or professional student, on the other hand, can borrow up to $20,500 each year in Direct Unsubsidized Loans. 

The four types of Direct Loans are:  

  • Direct Subsidized Loans: These loans are available to eligible undergraduate students with financial need.  
  • Direct Unsubsidized Loans: These loans are available to eligible undergraduate, graduate, and professional students. Eligibility for Direct Unsubsidized Loans is not based on financial need.  
  • Direct PLUS Loans: These loans are available to parents of dependent undergraduate students and graduate or professional students. Direct PLUS Loans cover educational expenses that aren’t covered by other financial aid options. This type of student loan is not determined by financial need. A credit check is required for all borrowers. 
  • Direct Consolidation Loans: These loans enable you to combine all of your eligible student loans into one loan with a single loan servicer. A loan servicer is a company that collects payments, responds to customer service inquiries, and performs administrative tasks. 

Federal student loans have a fixed interest rate and typically have lower interest rates than private loans. For this reason, we recommend seeking federal student loans first. However, we know these loans are not always enough for students to pay for their education, housing, and food. Even with scholarships and federal student loans, you may need additional funds, which is where private student loans come into play. 

Quick Guide to Private Student Loans

Banks or financial institutions often offer private student loans. Private student loans are available to parents, family members, undergraduate students, students seeking certificates, and graduate or professional students. These loans can be used for tuition, housing, institutional fees, supplies, books, and more. 

Since these loans are private, they require a credit history. Many students do not have an established credit history yet, which is why private student loans often require a co-signer. Having a co-signer with a good credit score will help increase your chances of approval. Moreover, you might get a better rate on your loan. 

Private student loans are a great option for students after they’ve considered all federal student loan options first. Once you’ve received federal student loans, check to see if your institution has a preferred lender list. 

A few key features separate good and bad private student loans: 

  1. One important thing to note is reasonable or fixed interest rates. Like federal student loans, some private student loans offer a fixed interest rate. Make sure to read the fine print, as most private student loans have variable interest rates, which can change from one period to the next. 
  2. Next, check to ensure that the loan has little to no fees, which can include surcharges for sending a check, printing out a bill, or a late fee. These fees can add up, which is why it’s important to know the fine print. 
  3. It’s also necessary to choose a private student loan with favorable terms. For example, it’s important to know when you will have to start paying off your loans and make sure that you can stick to a payment plan. 
  4. Lastly, look out for a company with good communication. This is especially vital if, for some reason, you might need to extend your payment period. Lenders can offer assistance during troubling times so that your credit score isn’t affected. Make sure to choose a lender with great customer service in case anything happens. 

What Are High-Risk Loans?

High-risk student loans target students in need of quick cash. In this section, we’ll explain three high-risk loans that you should avoid: payday, title, and personal loans. First, we’ll explain each high-risk loan and the implications on your credit score and beyond. Then, we’ll offer a possible solution so that you can avoid high-risk loans. 

Payday Loans 

Payday student loans are typically for emergency circumstances. You can get a loan response in as little as an hour in some cases. Although this type of loan does not check the borrower’s credit history, any overdue loans will be reported to the credit bureaus. Additionally, any break in your contract could result in serious ramifications. Receiving the money you might desperately need for school as quickly as possible may sound appealing, but it can be followed by great risk. 

What Happens If I Can’t Repay a Payday Loan? 

The penalties for nonpayment vary from loan to loan. Ascin.com, for example, notes that penalties for a loan up to $500 can range from 15% to 40% of the entire loan amount. For loans that exceed $500, charges can be even more. 

In addition, lenders within their network can charge you fees for being late and not having sufficient funds. If a loan is late, you might have to pay 15% of the loan balance as the late fee, which can add up. 

Title Loans 

Title loans are high-interest loans that use your car title as collateral. They are meant to be short-term loans and repaid within 15 to 30 days with accompanying fees and interest rates. The rates for this short-term loan can be up to triple digits, making this a high-risk loan. Typically, the company will lend up to 25% of the car’s total value to the borrower. In case of a default, the lender will have the car title as collateral.

What Happens If I can’t Repay a Title Loan? 

Although title loans don’t necessarily impact your credit score, not being able to repay them could result in your vehicle’s repossession. Any repossession will show on a credit report and hurt your overall credit score.

Personal Loans

Personal loans can come from traditional banks, credit unions, and online lenders. These loans generally have a fixed rate that can be paid monthly within a 24- to 60-month term, although the term can be different depending on the lender. On that note, the amount you can borrow for a personal loan depends on who you are lending from. Some loans can be as little as $500, while another might be up to $35,000. 

Occasionally, lenders do not have borrowing fees, but they often have additional fees that depend on the lender’s terms. Approval requires good credit, and secured personal loans do not usually require collateral. However, if you do not opt for a secured personal loan, you might have collateral like your house or car. 

What Makes a Personal Loan a High-Risk Loan? 

Not all personal loans are bad, so we recommend looking into the lease terms and APR. The annual percentage rate (APR) is an annualized representation of your interest rate. A personal loan can be considered a high-risk loan because of the ramifications of defaulting on the loan. Defaulting on any loan can impact your credit score, but with a personal loan, you could end up in collections. The most troubling aspect is that you could also be sued for the debt. 

Emergency Loan Options for Students 

It’s understandable that you might need emergency funding for your education, but know that you have options. Payday, title, and personal loans could jeopardize your financial future and add more stress in the long run.

Emergency student loans are a short-term option for college students that can cover tuition, fees, and personal expenses. They typically don’t have an interest rate, and the student will need to repay the amount in full at one time. If you find yourself in a financial emergency, contact your school. Some colleges offer students interest-free emergency student loans of up to $500.

At CollegeFinance.com, we understand that funding education while dealing with life can be challenging. Remember, though, that you have options to build your financial future and ensure you are getting the most out of your college investment. Learn how to minimize the cost of borrowing money to fund school and emergency expenses with the many resources that CollegeFinance.com offers.