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A subprime loan, like any loan, can hurt your credit if you miss any payments or default on the debt. But it can also help improve your credit if you make your payments on time.
Subprime is a term used for credit scores between 580 and 669 in the FICO® credit scoring model, which also corresponds with the fair credit range. In contrast, a prime credit score is usually considered between 670 and 739, and a super-prime credit score 740 and above. (These ranges may vary slightly by lender or credit scoring model.)
Consumers in the prime and super-prime ranges are a highly desirable group among lenders because their scores show they pose less risk and are more likely to pay back loans on time and in full. Still, many lenders are willing to issue subprime loans, which helps borrowers in that range boost their credit when they manage their loans responsibly.
What Is a Subprime Loan?
A subprime loan is a loan designed for borrowers who have subprime credit because they're either relatively new to credit or rebuilding their credit history after making some mistakes in the past.
Because lenders that offer subprime loans take on more risk than lenders that offer only prime and super-prime loans, subprime loans tend to come with higher interest rates. Some also charge additional fees that increase the total cost of the loan.
Depending on the type of loan, that cost difference could be in the hundreds of dollars or—with a mortgage, for instance—tens of thousands.
How Subprime Loans Affect Credit
Subprime loans affect your credit scores the same way any other loan would. Your payment history is the most important factor in your scores, so it's essential that you make your payments on time every month.
One way to ensure this happens is to set up automatic payments from your checking account and always make sure there's enough in the account to cover what you owe. If you do happen to miss a payment, remember that it won't be reported as late on your credit report until 30 days after the due date.
If it's just a few days late, you may be charged a fee, but it won't show up on your credit history if you pay it promptly.
How to Get a Subprime Loan
Many lenders that offer prime loans also offer subprime loans. Start by checking with your local bank, but also consider others that may be able to offer more favorable terms for your situation.
Credit unions, for instance, have a federal cap of 18% on subprime loan interest rates, which is lower than what you might get from other lenders. However, you may need to be a member before you can apply.
Another option to consider is an online lender. Many online lenders allow you to get prequalified before you apply so you can get an idea of what rate and other terms you might get. This allows for easier comparison and prevents you from having to rack up credit inquiries as you shop around.
As with any loan, it's best to check with at least a few lenders to improve your chances of getting the best terms based on your qualifications.
Improve Your Credit Before Applying
It's possible to get approved for a loan with subprime credit. But if your financing needs aren't urgent, it may be better to wait and work on your credit so you can qualify for a prime loan with a better interest rate.
For example, if you're behind on payments with a loan or credit card, get caught up as quickly as possible and make on-time payments going forward. If you have a high balance on a credit card, work on paying it down to lower your credit utilization rate, which is the amount of revolving credit you're using as compared with your total credit limits.
Also, check your credit report for errors. If you find anything incorrect or fraudulent, you can dispute it with the credit reporting agencies to have it corrected or removed.
Improving your credit scores can take time, but it can save you a lot of money over the long run.
Avoid Making a Rush Decision
If you're looking for a subprime loan, it's important to take your time to research various options. If you take the first offer you get, you may end up paying more without ever knowing it.
It's especially important to avoid short-term loans like payday loans and auto title loans. While easy to get, these loans often charge triple-digit interest rates and give borrowers little time for repayment, often requiring them to take out more debt to pay off the first one.
Ultimately, getting your credit scores into the prime range can save you the most money. But if you need cash now, compare at least three to five lenders before you apply.