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Getting a subprime loan is something like receiving a fourth-place trophy: It's a lot better than walking away empty-handed, but it's not a goal you'd likely set for yourself.
Subprime loans are a category of loans with relatively high interest rates and fees that are offered to borrowers with less-than-ideal credit. So if you get a subprime loan, it's usually because you can't qualify for a conventional loan—in other words, one with better borrowing terms.
"Subprime borrowers" refers to individuals who qualify for subprime loans. Many lenders that issue mainstream loans also offer subprime loans, and there are also subprime lenders that specialize in lending to applicants with subpar credit.
What Does Subprime Mean?
Experian defines subprime borrowers as those with FICO® Scores* in the fair range: between 580 and 669 on the FICO scale of 300 to 850. Credit scores in this range are below average when compared with all U.S. adults, and borrowers with fair scores are statistically more likely than the average borrower to fail to repay their loans. Many mainstream lenders choose not to do business with applicants whose credit scores fall in this range because they are seen as risky borrowers.
But other lenders actively seek out subprime borrowers, with the understanding that they can hedge against repayment risk by charging higher interest rates and fees. Large lenders may seek a mix of customers with different risk profiles, including both low-risk and subprime borrowers, while other lenders focus exclusively on the subprime market.
How Do Subprime Loans Work?
Subprime lenders issue loans used for many of the same purposes as more conventional loans. You can find subprime car loans, subprime mortgages and subprime personal installment loans.
Subprime lenders typically require larger down payments on purchases than they require on conventional loans. For instance, A borrower with strong credit who qualifies for a conventional car loan might have to pay 5% of the purchase price in the form of a down payment (and buyers with great credit can qualify for 0% down), but a subprime borrower might need to put down 10% or more.
Once you've been approved for a subprime loan, what sets your experience apart from a similar conventional loan is cost. Over the life of the loan, you will spend considerably more on a subprime loan than you will on a conventional loan for the same amount. Those extra expenses take several forms:
- Higher interest rates. You can expect the annual percentage rate (APR) on a subprime loan to be at least a point or two higher than it would be on a conventional loan. On a car loan, that can represent thousands of extra dollars over the life of the loan; on a mortgage it can mean tens of thousands of dollars.
Here's an example. Using FICO's Loan Savings Calculator for a straightforward comparison on a 30-year, fixed-rate $150,000 mortgage in Illinois:
- A borrower with a fair FICO® Score of 650 can expect a loan APR of about 4.80%, and total interest payments over the life of the loan of just under $133,500.
- A borrower with a FICO® Score of 700 (which falls in the good FICO® Score range of 670-739) can expect an APR of about 3.99% and total interest costs just under $107,500—a savings of more than $25,000 over the life of the loan.
- Adjustable interest rates. In contrast with the fixed interest rates, which stay constant over the life of many conventional loans, the interest rates on many subprime loans, especially mortgages, can increase over the course of the repayment period. You can compare these loans based on their introductory rates, which are variously guaranteed (or locked) for one, three, five or seven years, after which the rates can change annually. Rate adjustments are calculated based on a published metric, such as a market index, but they can be hard to predict and plan for.
- Higher fees. Origination fees—upfront service charges you pay the lender for handling the loan—are often significantly higher on subprime loans than on conventional loans. (Lenders may or may not allow these fees to be paid over the life of the loan, in the form of an increased the monthly payment.) Late-payment fees are likely to be steeper than on conventional loans as well.
- Longer repayment periods. Subprime lenders may insist on extended-term loans that require years longer to repay than similar conventional loans. For instance, they might require a five-year (60-month) auto loan instead of a more conventional 36- or 48-month loan, or a 40-year mortgage instead of a more traditional 30-year home loan. While this can lower monthly payments, a stretched-out repayment period can combine with steep interest rates to increase the overall cost of the loan significantly.
How to Get a Subprime Loan
While the FICO® Score range of 580 to 660 is broadly applicable to subprime borrowers (and helpful for analyzing trends), it's worth noting that it's not an absolute definition. In an important sense, subprime means whatever a particular lender decides it means. Using credit scores to segment applicants into categories, lenders can define subprime as they see fit, just as they define prime to denote attractive borrowers, and superprime to indicate borrowers with exceptionally good credit.
So checking your credit score yourself will give you a good idea if you're a candidate for a subprime loan but, because lenders define subprime differently, the best way to find out what loans you qualify for is to start applying for them.
Before you do, bear in mind that your credit score may define your status as a subprime lender, but it's seldom the only criterion lenders consider when deciding whether to issue a loan. In addition to checking your credit report and one or more credit scores, lenders will likely want you to provide proof of income (a recent pay stub typically suffices) and verification of employment (provide contact information for your supervisor or HR representative.) If you're seeking a mortgage, they may also ask about your savings, investment holdings or other assets.
If you have poor credit or no credit at all and want to get a loan without a credit check, talk to banks or other lenders to find out if they will consider alternative data, such as proof of income and employment verification, instead.
Once you've got your supporting information in hand and you're ready to begin applying for loans, here are some things to keep in mind:
- A good place to start looking for any loan is the financial institution that handles your checking and savings accounts. Banks and credit unions may have a little more leeway to work with an established customers than they would with other subprime borrowers.
- Whichever type of loan you seek, you should apply to at least three or four lenders, including national lenders as well as local sources. While some may turn down your application, others may accept it—and among those who accept, some may offer better terms than others. Applying for credit triggers a hard inquiry on your credit report, which can cause a temporary credit score drop, but credit scoring systems treat multiple applications within the span of a few weeks as a single event, so you aren't penalized for loan shopping.
- If you're seeking an auto loan or a personal loan, online tools such as Experian CreditMatch™ can use your credit score to help you find lenders willing to work with you. Many mortgage lenders also provide online application tools.
- If you're looking for an auto loan, the finance manager at a dealership may be able to help steer you in the right direction. Don't feel obligated to seek out dealers that specialize in "bad credit"; most dealerships work with multiple finance companies, including subprime lenders. They can help you shop around for the best deal you qualify for, on a new or used car.
Can Subprime Loans Hurt Your Credit?
There's nothing about a subprime loan in and of itself that can damage your credit. In fact, taking out a subprime loan can help improve your credit score, as long as you make your payments on time every month. If you don't make timely payments, your credit score will suffer, but that's true with any type of loan.
Anytime you take out a new loan, your credit score dips temporarily, until you show you're able to keep up with your payments over a period of several months. Again, that affects people with excellent credit scores as well as subprime borrowers.
Improving Your Credit Scores
If you need to seek out subprime loans, by definition your credit history—and the credit scores that reflect it—aren't very strong. That may be because you're new to credit and haven't established a pattern of responsible bill payments, or it could be because your history reflects late or missed payments, or even more serious financial concerns such as foreclosure or bankruptcy.
In addition to keeping up with your loan payments, you may be able to take other steps to improve your credit, such as:
- Paying down any outstanding balances you may have on your credit card accounts. Balances that exceed roughly 30% of your borrowing limit can lower your credit score significantly.
- Checking your credit reports for any inaccurate entries that may be damaging your score and following up with the relevant credit bureau(s) to correct them.
- Working with certified credit counselors at nonprofit agencies to develop a strategy for credit improvement.
- Enrolling in Experian Boost™† , which can help increase your FICO® Score from Experian by giving you credit for paying your phone and utility bills on time.
Subprime lenders perform a valuable service by enabling people with limited or imperfect credit to finance things they need. If you're a subprime borrower today, by managing that debt carefully and taking other steps to improve your credit, there's a good chance you won't have to resort to a subprime loan the next time you seek credit.