Subprime loans are offered to borrowers that lenders believe to have a high risk of default, usually because their credit is below the lender’s usual standard. They almost always carry high-interest rates and other associated costs, but for many borrowers with impaired credit, they may be the only loans available.
Many online and bricks-and-mortar lenders who offer regular loans also offer subprime loans. Some specialized subprime lenders focus entirely on lending to borrowers with credit problems. Subprime loans usually require higher down payments and have higher borrowing costs than other loans, so it’s important to compare quotes from several lenders and look for alternatives.
What is a Subprime Loan?
Any loan made to a subprime borrower is considered a subprime loan. A subprime borrower is one that does not qualify for regular loans due to their credit history or other important financial factors.
Most subprime borrowers have credit scores below what a lender typically requires for a normal loan. A borrower may also be considered subprime because of their existing debt load, income, employment status, or other reasons. Some borrowers may be considered subprime because they have a limited credit history, even if they have no history of defaults or missed payments.
Many lenders consider these borrowers too risky for their usual loan terms but might lend to them with higher interest rates and fees. Some lenders actively seek out subprime borrowers, offsetting the higher risk with higher income from interest and fees associated with subprime loans.
Most types of loans are available to subprime borrowers, including personal loans, car loans and mortgages.
There is no fixed definition of a subprime borrower. Each lender has its own criteria for a prime borrower, a subprime borrower, and a borrower that they will not lend to at all.
Where Can I Get a Subprime Loan?
There are several places where you can get a subprime loan:
- Your own bank or credit union is often a good starting point in your search for a subprime loan. Many banks are willing to grant more latitude to established customers, and you will have direct access to loan officers that can work with you.
- Many online lenders offer subprime loans, and some specialize in subprime loans. They usually list their lending criteria on their websites, so you can easily select lenders that are likely to lend to you. However, these lenders may or may not have the kind of support you want as compared to a bank or credit union.
- Online peer-to-peer (P2P) lending services match potential lenders with potential borrowers. Terms are often competitive and many P2P lending services are willing to work with subprime borrowers.
There may be banks or other lenders in your area who specialize in subprime loans. Be sure to do some research into an unfamiliar lender before applying. Online searches can often turn up information, as can queries to the local Better Business Bureau or your state’s financial regulatory authorities.
If you are looking for a car loan, talk to the car dealer about financing options. Even dealers who do not specialize in serving subprime customers may be able to link you to a subprime lender.
You will want to apply with several lenders. Make a list of lenders in different categories that are reputable and established and offer reasonable terms on subprime loans.
How Do I Apply for a Subprime Loan?
Start by checking your credit scores and credit reports. Review your credit reports to see if there are errors that could be hurting your credit.
Lenders may also use criteria beyond your credit report to determine the risk you present, so make sure you have additional finances on hand. You will probably need proof of employment and income, like pay stubs. Banks will consider your debt-to-income ratio and your employment status.
If you’re applying for a subprime mortgage you may need evidence of any savings, investments, or other assets you own. You may also be asked for evidence of your current housing costs, such as rent receipts.
Check the lending requirements of the potential lenders you’ve selected and compare them to your financial data. Make an honest assessment of where you stand. If your credit information is only slightly into subprime territory you may find a lender who won’t consider you subprime: remember that different lenders have different criteria for defining subprime borrowers.
Additionally, some lenders are willing to make decisions based on “alternative data”, which is information that is not in your credit report. This can be useful if your credit problems are a result of a limited credit history rather than derogatory entries. If you have a regular job, an adequate income, and a good history of making payments but your credit file is too thin to allow a high score, look for lenders that are willing to consider alternative data.
Select several lenders with standards that fit your qualifications. Apply for these loans according to the lender’s instructions.
Each application will generate a hard inquiry on your credit report, but if you make all of your applications within a two-week period the credit reporting companies will recognize that you are shopping and register only a single inquiry.
If you are approved by more than one lender, you’ll need to compare the offers carefully. Make sure to:
- Compare the interest rates, APRs, loan terms, and fees for each lender.
- Read the fine print and look for hidden fees or potential issues hidden in loan agreements.
- Make sure you understand all the terms and obligations that come with your loan and consult with an outside expert if possible.
Choose the proposal that best fits your needs. It’s easy to get carried away by relief that you were even approved for a loan and sign the first proposal you get. Remember that if one lender approves you, others might do the same and they could offer better terms.
What Are the Costs and Risks of a Subprime Loan?
Subprime borrowers present a higher risk of default than prime borrowers. Lenders offset that risk by imposing higher borrowing costs. These are some of the costs you’re likely to face in the subprime loan market.
- Higher down payments. Subprime lenders often try to reduce their risk by imposing higher down payments on subprime borrowers than they would on prime borrowers, particularly on car loans and mortgages.
- Higher fees. Many loans have origination fees, which cover the costs of processing the loan. There may also be late payment fees and other potential penalties. Subprime loans often carry higher fees than prime loans. Be sure to read loan proposals carefully and note all fees.
- Higher interest rates. Subprime loans often carry significantly higher interest rates than prime loans. A small difference in the interest rate can translate into much higher costs, especially on larger, longer-term loans like a car loan or home loan.
- Variable interest rates. Interest rates on many subprime loans can increase during the loan’s term. This can make costs difficult to predict and manage if you aren’t paying attention. In some cases, an introductory rate may be locked in for a certain number of years, but once that period is over the interest rate could change.
- Longer loan terms. Subprime loans often come with longer repayment terms than prime loans, and there may be a prepayment penalty that will be imposed if you pay early. A longer-term can make your monthly payments smaller, but it can increase the total amount of interest you’ll pay on your loan.
These costs may significantly increase the total cost of a loan. That additional cost may be difficult for some borrowers to meet, especially if they face unexpected financial problems. Higher costs raise your risk of default, which can have a serious impact on your credit.
Some lenders will lend to subprime borrowers even if it is likely that the borrowers will default. These are known as “predatory” lenders. Watch out for high-pressure sales techniques, offers that seem too good to be true, sudden changes in fees or costs, or extremely high rates or fees. If you have doubts, stop the deal until you’ve done more research.
Predatory lenders tend to focus on the low end of the subprime market, looking for desperate borrowers who may have been rejected by reputable lenders. If your credit is low enough that the only lenders who will approve you are predators, you may wish to consider postponing borrowing.
Some online lenders may also advertise a very low rate to generate inquiries and then try to sell you a loan with a potentially very different set of terms. Be alert. Never pay upfront for a pre-approval or quote.
Alternatives to a Subprime Loan
Subprime loans are expensive, and you may wish to consider some alternatives.
- Postpone borrowing until your credit is better. If your loan is not essential, you may wish to put it off and focus on rebuilding your credit. Driving the same old car for a few more years or renting for a bit longer could get you much better terms.
- Borrow the smallest amount possible. If you must borrow, look for ways to minimize the amount you borrow. If you have to buy a car, for example, consider a less expensive used model. Smaller loans can be paid off faster and will accrue lower interest costs.
- Look for lenders with more relaxed standards for prime loans. Remember that not all lenders define “subprime” the same way. Just because one lender considers you subprime doesn’t mean all lenders will do the same.
- Look for lenders who are willing to consider alternative data. If you believe that your financial status is better than your credit score suggests and you have evidence to support that belief, search for lenders who will consider alternative data. You may qualify for a prime loan even without the required credit score.
- Consider getting a cosigner. A cosigner with better credit may allow you to qualify for better terms. Be sure that both you and your prospective cosigner fully understand a cosigner’s obligations and risks.
- Government-insured mortgage programs are available to many qualified subprime borrowers. If you’re looking at a subprime mortgage, consider loans insured by the Federal Housing Administration, Department of Agriculture, or Veteran’s Administration.
If you are considering a longer-term subprime loan like a car loan or mortgage, remember that if your credit improves during the loan term you may be able to refinance with a loan at better terms. This will only be a viable option if you keep your loan payments up to date and your finances in order!
Should I Consider a Subprime Loan?
Subprime loans are expensive and risky. That doesn’t mean a subprime loan is always the wrong choice, but it does mean you should be aware of the costs and risks and weigh them carefully against the benefit you expect to receive from the loan.
For some borrowers, subprime loans may be the only financing available. If the loan is affordable, the benefits justify the costs, and you choose the cheapest loan you can get from a reputable lender, a subprime loan can provide the financing you need to achieve your financial goals.