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"Subprime" is a term lenders use to describe credit applicants who are likelier than most to have difficulty repaying their debts.
While some lenders choose not to work with subprime applicants, other lenders extend credit to subprime borrowers with the understanding that they can charge them higher interest rates and fees to compensate for assuming greater risk. Some lenders even specialize in issuing so-called subprime loans.
Who Is Considered a Subprime Borrower?
Lenders typically identify a subprime borrower using their credit scores, which are based on the applicant's credit history as recorded in credit reports at the three national credit bureaus (Experian, TransUnion and Equifax).
Experian defines subprime borrowers as those with a FICO® Score☉ in the fair range, between 580 and 669. FICO® Scores in this range are below average when compared with all U.S. consumers, and borrowers with fair scores are statistically more likely than the average borrower to fail to repay their creditors.
As of the fourth quarter of 2018, 34.8% of U.S. consumers who have credit scores fell into the subprime FICO® Score range, according to the most recent research from Experian. That's down slightly from 35.6% in the fourth quarter of 2017.
Those figures are useful for discussion purposes, and for studying trends, but it's important to remember that subprime isn't an absolute designation.
In a very real sense, subprime (like "prime," the term used for credit applicants with more lender-desirable credit scores) is a moving target. Each lender defines subprime and prime as they see fit, depending on their lending strategies and business goals. What's more, different lenders define subprime using different credit scoring systems, including industry-specific scores, multiple versions of the FICO® Score, VantageScore, or even custom systems designed by the lender itself.
No matter how a lender defines subprime, the subprime loans offered to subprime borrowers typically carry higher interest rates and fees than those offered to prime borrowers—differences that mean subprime borrowers may pay much more than their neighbors with prime credit scores.
Types of Subprime Credit and Loans
Many lenders have loans and credit card products geared toward subprime borrowers, and some lenders even specialize in subprime lending, although very few advertise themselves as such. If you think your credit falls into subprime territory, it may be hard to know which loans and credit cards you may qualify for until you apply.
One good place to start is the bank or credit union you use for your everyday finances.
Alternatively, if you've received any offer or preapproval letters in the mail for the type of credit you need, consider those as well; chances are good they've used your credit score to target you and have a good idea of your credit standing already.
Other borrowing opportunities subprime borrowers should consider include:
- Government-backed mortgage programs:
- FHA loans. Low interest mortgages backed by the Federal Housing Authority (FHA) are available with a 3.5% down payment to borrowers with credit scores of 580 or higher, and to borrowers with scores as low as 500 who can make a 10% down payment.
- USDA loans. U.S. Department of Agriculture (USDA) loans are available with a minimum credit score of 640 to borrowers who meet income guidelines and are buying homes in rural areas.
- Subprime auto loans:
- The financing officers at most car dealerships work with a variety of lenders, including subprime auto lenders. Depending on your credit score and income, they may offer a lower loan amount than a conventional lender might, and at a higher interest rate, but they may be able to help you get behind the wheel.
- If you don't have any luck at a traditional dealership, consider as a last resort shopping at a buy-here-pay-here dealer that offers direct financing.
- Secured credit cards: If you've been unsuccessful in applying for a credit card, consider getting a secured credit card as an interim option. With a secured credit card, you provide the lender with a sum of cash as collateral, and that amount becomes the borrowing limit on your card. You use the card as you would any other credit card, and as long as you maintain as low a balance as possible, and make your payments on time every month, your credit score will tend to improve so that after a year or so, you may be able to upgrade to a standard, unsecured, credit card.
Difference Between Subprime and Prime Consumers
What makes one consumer a subprime candidate for credit and another a prime borrower? The simple answer is that prime borrowers have higher credit scores than subprime borrowers, but that's just scratching the surface.
Credit scores are derived from information found in the credit reports compiled at the national credit bureaus. Those reports, in turn, record your history of managing and repaying debt. They contain information about loans and credit cards you've taken out (including loans you may have paid off completely and credit card accounts you closed as long as 10 years ago). Credit reports keep tabs on your accounts, whether those payments were late or on time, and how close to your credit limits you are on your credit cards. If you've suffered severe financial setbacks, including bankruptcy, home foreclosure, vehicle repossession or the submission of unpaid bills to collection agencies, those events may appear on your credit report as well.
Credit scoring systems apply sophisticated statistical analysis to the information in your credit report and, based on the historical actions of millions of consumers, look for combinations of behavior that indicate how likely you are to fail to repay your debts. This forecast is distilled into a three-digit number, typically on the scale of 300 to 850 used for both the FICO® Score and current versions of the VantageScore® system. A person with a higher credit score is statistically more likely to pay their bills than someone with a lower credit score.
A person might have a credit score in the subprime range for at least a couple of reasons:
- So-called thin-file borrowers have little to no evidence of experience with debt and credit, and therefore lack enough of a track record to have earned a higher score. With time and consistent timely payment of their debts, thin-file borrowers can steadily improve their credit scores.
- Other borrowers may have subprime credit scores because mistakes or missteps in the past led to negative information in their credit reports that are hurting their credit scores. These borrowers can improve their credit scores as well, but the amount of time needed to do so may depend on the severity of the negative information.
From a lender's standpoint, the difference between a prime borrower and a subprime borrower can be significant. While subprime borrowers are often limited to loans and credit cards with higher interest rates, and fees and relatively low borrowing limits, prime consumers have a greater range of choice, with better rates and terms available.
How to Become a Prime Consumer
Credit scores reflect an individual's credit management decisions. They can and do change, and the best way to move from the ranks of subprime borrowers to those of prime credit applicants is to develop habits that promote improvements in your credit score.
These include paying your bills on time every month, avoiding excessive balances on your credit cards, and demonstrating successful handling of a variety of different loans and credit types.
With patience and determination, it's possible for subprime borrowers to earn higher credit scores and enjoy the benefits of a prime credit score.