What Is A Subprime Auto Loan?
Subprime auto loans are a type of financing offered to borrowers with weaker credit scores or even to people who have no credit. Subprime loans feature higher interest rates and are accompanied by prepayment penalties if a borrower wants to repay the loan early.
The reason for the higher interest rate is the increased likelihood of borrower default. Accordingly, lenders price these loans higher to compensate for the lending risk. Subprime auto loans may also require larger down payments.
Depending on the agreed upon loan terms , the repayment duration can be as long as 84 months in certain cases. While this can ultimately help lower monthly payments and make a vehicle more affordable, a borrower will end up paying more in interest over the life of the loan.
How It Works
According to data collected by U.S. News & World Report, borrowers with credit scores of 620 and below have a higher likelihood of default. When evaluating a loan application, a credit score is among the main determinants for lenders. According to the Consumer Financial Protection Bureau (CFPB), a credit score between 580 to 619 is considered under subprime whereas Experian deems scores between 501 to 600 subprime.
Bear in mind that due to the additional risks involved with lending to subprime borrowers, lenders might urge you to provide additional details including the ones listed below during the application process:
- Before lending money, the lender may ask to see pay stubs or W-2 or 1099 forms as income proof. Many lenders accept bank statements.
- The interest rates offered are comparatively higher than any other loan, and possibly three times the rate offered on prime loans.
- The terms of the loans are generally 60 months but can be extended depending on the lender.
Interest rates can vary from lender to lender and also depends on the type of vehicle, whether it's used or new, and the term of the loan. Below are some representative auto loan interest rates from 2019 for a range of borrowers:
New Car Loan Rates:
- Subprime loans for credit scores ranging between 450-649 generally see APRs of 13.23%.
- Deep subprime loans for credit scores of 449 or lower carry an average rate of 17.63%.
- Nonprime loans for borrowers with scores between 650 -699 feature APRs of approximately 7.65%.
Used Car Loan Rates:
- Subprime borrowers can expect rates near 12.05%.
- Deep subprime borrowers can anticipate a rate of approximately 15.44%.
- Nonprime borrowers can access a rate around 6.43%.
Who Should Get One?
A subprime auto loan is offered to borrowers who don’t qualify for conventional loans. There are certain characteristics that make subprime auto loans the best bet for certain borrowers including:
- FICO credit score below 650 (according to Equifax)
- Low income
- Little to no credit history
- A debt-to-income ratio below 50%
- No foreclosure in the last 24 months
- No bankruptcy over the last 60 months
Why You Should Shop Around
You should never settle for the first loan you’re offered. You should always shop around and compare all the available offers to ensure you’re accessing the best possible terms.
Predatory lenders are always in search of desperate borrowers with limited options or knowledge about loans in order to charge high-interest rates and fees. They also tend to hinder a borrower’s ability to repay the loan by taking advantage of the borrower’s situation.
The more you shop around, the more familiarity you’ll have with available market rates. This can help you negotiate better loan terms.
What To Look Out For
Subprime loans have a bad reputation because of their name, higher interest rates, and the association with predatory lending. Below are some characteristics to consider when deciding if a subprime loan is right for you:
- Subprime loans carry more risk for lenders, leading to higher interest rates for borrowers.
- Borrowers are more likely to default on these loans because of the high-interest rates, which can ruin their credit.
- Subprime loans have higher-interest rates than the regular loans which can result in high monthly payments.
- Predatory lenders charge much higher interest rates or even hide fees which ultimately harm unprepared borrowers.
- Many borrowers aren’t able to afford additional amounts like processing fees and high up-front down payments.
Regardless of your credit score, there are assuredly lenders willing to approve your auto loan application. However, with a weaker credit score, you might only be entitled to higher interest rates and less than ideal terms.
Before you decide to take a subprime auto loan, always conduct careful research and compare offers to ensure that you are accessing the best terms for your circumstances and can afford to repay the loan without too much financial strain.