Definition of a risky auto loan

What is a subprime auto loan?

A subprime auto loan is a type of loan used to finance the purchase of a car that is offered to people with a low credit rating or limited credit history. Subprime loans carry higher interest rates than comparable prime loans and may also carry prepayment penalties if the borrower chooses to prepay the loan. However, so-called subprime borrowers may have no other way to purchase an automobile, so they are often willing to pay the higher fees and rates associated with these types of loans.

Subprime auto loans became big business following the monetary expansion from 2001 to 2004, along with subprime mortgages and other forms of higher risk personal or business loans. Financial institutions had so much money that they were looking for the higher returns that could be achieved by charging higher interest rates to subprime borrowers.

The term “subprime” was actually popularized by the media a little later, during the subprime mortgage crisis or the “credit crunch” of 2007 and 2008. The ranks of subprime lenders thinned after the Great Recession, but they made a comeback.

Key points to remember

  • Subprime auto loans are available to people with poor credit scores or limited credit history.
  • Subprime auto loans have higher interest rates than regular auto loans.
  • The fees can vary on subprime auto loans; shop around if you need to resort to one.

How a subprime auto loan works

There is no official cut-off score for subprime status (versus prime), but generally the borrower’s credit score must fall below a FICO score of 650 and above 450 to be considered subprime. (FICO scores vary between 300 and 850.) In general, less than 20% of Americans fall below 600; 22% are between 600 and 699, and 22% are at 800 or more, according to NerdWallet.com in September 2019.

450 to 650

The credit score range for a subprime auto loan.

When assessing a borrower, an auto lender may ask to see pay stubs or W-2 or 1099 forms to prove income. If a borrower has a profession in which it is difficult to prove income (a restaurant waiter who has a lot of income in the form of cash tips, for example), they may need to bring bank statements showing a history of deposits. in constant cash to their account. Some lenders will accept bank statements in place of or in addition to standard pay stubs.

In general, it is best to compare rates if you are forced to take out a subprime loan. Not all lenders use the same criteria and some charge higher fees than others. The interest rates can be quite high compared to a standard car loan because the lender wants to make sure that they can recoup the costs in the event the borrower defaults.

Alternatively, borrowers can try to improve their credit rating before trying to obtain financing for the purchase of an automobile. This way, they could qualify for a loan on much better terms.

Although there is no official subprime car loan rate, it is usually at least three times the prime loan rate and can even be up to five times higher.

Examples of subprime auto loan rates

Since there is no official subprime credit score, there is therefore no official subprime auto loan rate. Interest rates vary among lenders and, of course, depend on the type of vehicle (new or old) and the length or length of the loan. Here are the typical interest rates that can be expected when purchasing a 60 month auto loan to buy a new or used vehicle from September 2019.

New car loan:

  • Excellent (750 or more): 4.30%
  • Premium (700 to 749): 4.28%
  • Non-prime (650 to 699 credit score): 7.65%
  • Subprime (450 to 649): 13.23%
  • Deep subprime (449 or less): 17.63%

Used car loan:

  • Excellent: 4.20%
  • Premium: 4.21%
  • Non prime: 6.43%
  • Subprime: 12.05%
  • Deep subprime: 15.44%

As you can see, the rate jumps dramatically between borrowers with acceptable credit scores and those with subprime status. A car loan calculator can provide a more detailed window into how a credit score will affect the interest rate on a loan and, by extension, the monthly payment.

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