Labels like prime and subprime help denote loans that are designed for people with different credit scores. Prime loans are built for borrowers with good credit, while subprime loans are designed for those with less-than-perfect credit. While subprime loans can help this group finance big purchases like a home or a car, they also come with potentially significant downsides.
Here’s a look at what you need to know about prime and subprime loans to help you make better borrowing decisions.
Prime Loan vs Subprime Loan
When you’re shopping for a loan, lenders will consider your credit history to help them determine how much default risk they’d be taking on were they to loan you money.
Your credit score is a three-digit representation of your credit history that lenders use to understand your creditworthiness. While there are different credit scoring models, the FICO® score is one of the most commonly used. Lenders and other institutions may have varying models for which credit scores determine prime vs subprime loans.
For example, Experian, one of the three major credit reporting bureaus, defines a prime loan as requiring a FICO score of 670 to 739. With a score of 740 or above, you’re in super prime territory. Borrowers with a FICO score of 580 to 669 will likely only qualify for subprime loans.
Here are some key differences between the two that borrowers should be aware of.
Interest Rates
Borrowers with lower credit scores are seen as a greater lending risk. To offset some of that risk, lenders may charge higher interest rates on subprime loans than on prime loans.
What’s more, many subprime loans have adjustable interest rates, which may be locked in for a short period of time after which they may readjust on a regular basis, such as every year. If interest rates are on the rise, this can mean your subprime loan becomes increasingly more expensive.
Down Payments
Again, because subprime borrowers may be at a higher risk of default, lenders may protect themselves by requiring a higher down payment. That way, the borrower has more skin in the game, and their bank doesn’t need to lend as much money.
Loan Amounts
Subprime borrowers may not be able to borrow as much as their prime counterparts.
Higher Fees
Fees, such as late-payment penalties or origination fees, may be higher for subprime borrowers.
Repayment Periods
Subprime loans typically carry longer terms than prime loans. That means they take longer to pay back. While a longer term can mean a smaller monthly payment, it also means that you may end up paying more in interest over the life of the loan.
Prime Loan vs Subprime Loan: What Type of Loans Are They?
Prime and subprime options are available for a variety of loan types. For example, different types of personal loans come as prime personal loans or subprime personal loans \. When you’re comparing personal loan interest rates, you’ll see that prime loans offer lower rates than subprime. Common uses for personal loans include consolidating debt, paying off medical bills, and home repairs.
You can also apply for prime and subprime mortgages and auto loans. What is considered a prime or subprime score varies depending on the type of loan and the lender.
Recommend: How to Get Approved for a Personal Loan
Prime Loan vs Subprime Loan: How to Get One
By checking your credit score, you can get a pretty good idea of whether you’ll qualify for a prime or subprime loan. That said, as mentioned above, the categories will vary by lender.
The process for applying for a prime or subprime loan is similar.
Get Prepared
Lenders may ask for all sorts of documentation when you apply for a loan, such as recent paystubs, employer contact information, and bank statements. Gather this information ahead of time, so you can move swiftly when researching and applying for loans.
Research Lenders
Banks, credit unions, and online lenders all offer prime and subprime loans. You may want to start with the bank you already have a relationship with, but it’s important to explore other options too. You may even want to approach lenders who specialize in subprime loans.
To shop around for the best loan, you may want to apply for a few. That way you can see which lender can offer you the best terms and interest rates. Applying for credit will trigger a hard inquiry on your credit report, which will temporarily lower your credit score.
Consider a Cosigner
If you’re having trouble getting a subprime loan, you may consider a cosigner with better credit, often a close family member. They will be on the hook for paying off your loan if you miss any payments, so be sure you are both aware of the risk.
Subprime Loan Alternatives
There are alternatives to subprime loans that also carry a fair amount of risk. Some, like credit cards, are legitimate options when used responsibly. Others, like payday loans, should be avoided whenever possible.
Credit Cards
Credit cards allow you to borrow relatively small amounts of money on a revolving basis. If you pay off your credit card bill each month, you will owe no interest. However, if you carry a balance from month to month, you will owe interest, which can compound and send you deeper into debt.
Predatory Loans
Payday loans are a type of predatory loan that usually must be paid off when you receive your next paycheck. These lenders often charge high fees and extremely high interest rates — as high as 400%, or more. If you cannot pay off the loan within the designated period, you may be allowed to roll it over. However, you will be charged a fee again, potentially trapping you in a cycle of debt.
The Takeaway
Subprime loans can be a relatively expensive way to take on debt, especially compared to their prime counterparts. If you can, you may want to wait to increase your credit score before taking on a subprime loan. You can do so by always paying your bills on time and by paying down debt. That said, in some cases, taking on a subprime loan is unavoidable — you may need a new car now to get you to work, for example — so shop around for the best rates you can get.
If you’re paying more than 20% interest on your credit cards, a personal loan could be a great way to consolidate that high-interest debt. Borrow up to $100K with fixed rates and low APRs for those who qualify, and you could start paying a lower fixed monthly payment.
FAQ
Why are subprime loans bad?
Subprime loans are not necessarily bad. However, these loans charge higher interest rates and fees than their prime counterparts. Borrowers may also be asked to put down a higher down payment, and they may be able to borrow less.
What is the difference between subprime and nonprime?
Nonprime borrowers have credit scores that are higher than subprime but lower than prime.
What type of loan is a subprime loan?
A variety of loan types may include a subprime category, including mortgages, auto loans, and personal loans. All loans in the subprime category likely have higher interest rates and fees.
Photo credit: iStock/Nikola Stojadinovic
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