What are income-based loans?

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In a Nutshell

An income-based loan is a personal loan. You’ll often see this phrase on lender websites targeting borrowers with limited or less-than-perfect credit who need fast cash. But these loans can come with higher interest rates than those available to people with positive credit histories.
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An income-based loan might be an option if you have limited or less-than-great credit.

Have you ever needed money for an emergency? While everyone has to deal with financial emergencies sometimes, not everyone has access to quick cash or credit.

That’s where an income-based loan (which is really just a personal loan) could help. Some lenders could be using the term “income-based loan” to indicate they might be willing to extend personal loans to people who have little-to-no credit history but who show they have the income and ability to repay the loan.

If your credit isn’t great or you don’t have much of a credit history, getting a personal loan from a traditional bank can be more difficult because they often have stricter lending standards. But some lenders are more willing to look at your income and ability to repay when considering you for a personal loan.

The downside to a personal loan that’s based on income? Interest rates can be dangerously high in some cases. But if you use an income-based loan to help build your credit, you may be able to get better terms in the future.

Here’s what you need to know to help make the best decision for your circumstances.

How do income-based loans work?

Lenders will use different criteria and methods to determine if you’re eligible for an income-based loan (which again, is really just a personal loan). Some lenders perform a soft credit inquiry before offering you a loan while others won’t pull your credit history at all.

Note that it’s common for predatory lenders to offers loans without any credit inquiry at all. Watch out for this type of loan: It may have high interest rates and fees.

Payday loan lenders may not pull your credit, but they may require you to verify your income and bank account information. Because of the high fees that come with payday loans, it’s possible to get stuck in a debt trap.

Understanding secured vs. unsecured loans

Since income-based loans are personal loans, they can be either unsecured or secured loans.

When you get a secured loan, you offer a piece of property, like your car or home, to the lender as collateral for the loan. If you fail to repay the loan as agreed, the lender may be able to take the collateral to try to recover any unpaid amount.

On the other hand, an unsecured loan does not require you to put up any collateral, so it’s generally considered less risky to the borrower. But you’ll generally pay a higher interest rate because the lender faces a higher risk.

How can I apply for an income-based loan?

Even if your credit history is rough, you may be able to find a lender that weighs your income more heavily when deciding whether to issue a personal loan. But you’ll want to do your homework before making a decision.

Keep an eye out for this information as part of your loan application and loan terms.

  • Income verification: Lenders will typically verify your income so they can gauge how much you’re capable of repaying.
  • Loan amount: The amount you qualify for will depend on your income and credit history.
  • Loan term: Your loan term will typically range from six months to 60 months. Keep in mind that the longer the term, the more you’ll pay in interest. Although you’ll have higher monthly payments, you could save money with a shorter loan term.
  • APR: Personal loan APRs often range from 5% to 36% or more, but payday loans can have much higher APRs — even in the triple digits. This can include not just the interest rate on the loan but also any fees that you may pay.
  • Account information: Lenders may also often ask for your bank account details to verify your financial information.
  • Restrictions: Lenders may not offer their loans in some states.

How to use income-based loans to build your credit

If you get a personal loan it can help you build your credit if you use it responsibly. If you can raise your credit you may be able to qualify for better financial terms in the future.

Here are some ways you can use an income-based loan to improve your credit health.

  • Making your payments on time: Make sure your lender is reporting your on-time payments to the three major consumer credit bureaus — this is one of the most important factors that affects your credit scores.
  • Getting another form of credit: Getting a personal loan might add a new type of credit to your credit reports. Your credit mix — which considers different types of credit such as installment loans, credit cards and mortgages — is a factor in your credit scores, though not one of the most crucial.

Bottom line

An income-based loan can be a useful tool if you need money quickly and your credit isn’t great. Be sure to look into all the terms before choosing a lender — and if you’re able to use the loan to build your credit, you may be able to get better options in the future.

About the author: Poonkulali Thangavelu has 20+ years of financial journalism experience. Her work has appeared with outlets like Bankrate, Investopedia and various national newspapers. Poonkulali holds an MBA in finance and marketing … Read more.