Exjackly

This is part 2 in a series about bad debt. The parent is at What to do about Bad Debt and part one can be found at The Motivation Behind Bad Debt.

Unfortunately, not everything is simply a matter of cash or credit. With the wrong financial advisers or a bad financial background it is possible to get bad terms on your credit.

This can be a difficult position to get out of. If the problems that led to getting bad terms still exist, it will be difficult to find a way out that only includes good credit terms. Do the right things with your debt and it will eventually be possible to get good credit loans and terms even if all you can get approved for are bad credit loans and terms.

Bad credit terms can exist in a lot of ways. Here is a partial list with information on what you can do about them.

Prepayment penalty

This often caps off bad credit loans. Lenders who put this clause in their loans do so because they know how much of a good deal it is for them. They want you to be stuck in that loan for as long as possible so that they can make the most money off you. There are three ways out:

• Wait it out. If the term of the credit is short enough, you can make the payments until the prepayment penalty expires. Then refinance into a loan with more favorable terms.
• Refinance now. You will have to pay the prepayment penalty, but if you can get a more favorable loan by refinancing, the improvements in the terms may exceed the cost of the penalty. Try Bankrate’s Refinance Calculator (or any of the other 500,000+ such calculators out there). That calculator can be used for non-mortgage loans if you leave the correct valuesat zero.
• Negotiate. It will probably not work, but it cannot hurt to ask the lender if they will remove or reduce the prepayment penalty on the loan.

High interest rates

In general, a high interest rate is anything above 10%. Credit cards are almost always in this category. Even home mortgage rates have been above this threshold – even for prime borrowers. Most of the time however, any asset-backed loan (home mortgage, home equity line of credit or auto loan for example) should be below this rate.

• For any loan with an asset as collateral, try to refinance the loan to get a more favorable interest rate.
• For non-collateral loans, such as credit cards, it is often cheaper to get a better interest rate. You will probably not get a long term rate below 10%, but just by threatening to move the debt to a different credit card or to open a line of credit elsewhere, many companies are willing to offer you a reduced rate to stay. {No Credit Needed Blog} covers doing this in Call for Discounts.

Balloon

A payment balloon is simply one or several large payments to be made at the end of the loan. This is done to allow for a lower payment up front. This is favorable to the lender for two reasons.

First, the principal amount of the loan shrinks slower. This causes more interest to accrue over the life of the loan.

Second, if the economy is in a recession or the borrower has difficulties, the loan is unlikely to be paid off at the end, and the lender will either get to make another bad terms loan or will get possession of the house or car that was financed.

Negative Amortization

Negative amortization happens when the monthly payment is lower than the amount of interest that in generated each month. In other words, the loan gets bigger with every payment made. Eventually something will break. The loan must be refinanced or the monthly payment will have to suddenly grow much larger – large enough to pay off the loan in a compressed time frame plus the extra interest accrued.

Since negative amortization loans are generally used when somebody will not otherwise be able to get a loan, the refinance or larger payments usually becomes a financial disaster. These types of loans are a part of the sub-prime loans that are creating a crises in the American housing markets right now.

Extended Repayment Period

A loan that is financed over a longer than normal period of time is a great thing – for the lender. It secures payments for more years than normal, often at a higher interest rate, for only a small savings in monthly payments. No matter who tells you to do it, paying for a house over 40 or 50 years is not a good idea.

Conclusion

There are other terms that can be harmful to your financial health. The key is to carefully consider the downsides of any credit that you are offered before accepting and to not give in to a hard sell tactic, especially if it is designed to get you to ignore or treat the condition as minor. If it was that minor, it would not be in the contract.

If there are any in particular that you would like more information on, feel free to add a comment and ask. If you want more detail on any particular term listed above, I can get it for you as well.