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Subprime personal loans can help you obtain financial help if you’re being denied access to traditional loan products. However, because they’re usually tailored to low credit borrowers, the drawback is that they often come with high interest rates and fees. Nevertheless, they can provide a financial solution where there once was none.Read on to discover the answer to the question: What is a subprime loan? Learn what subprime loans are, how these loans work, and the steps to take to get a subprime personal loan.
What Are Subprime Loans?
Subprime loans are for borrowers who have any of the following characteristics:
Poor credit
Low income
Zero or limited credit history
Less than ideal collateral
What is a subprime loan? Essentially, a subprime loan is a funding option for borrowers who have trouble getting loans through a traditional route. Many different types of loans offer subprime options — such as subprime personal loans and subprime auto loans. While subprime loans are more expensive than other loans, they do serve a few purposes:
They provide borrowers access to needed funds.
They help borrowers who have no credit or poor credit the opportunity to build a stronger credit history with financial institutions.
What Is a Subprime Credit Score?
What constitutes a bad credit score? It depends on the credit score calculation used. FICO® Scores calculate a subprime credit score as anything between 580 and 669. Meanwhile, VantageScore® considers subprime to be any score between 300 and 600.
Can Subprime Loans Impact Your Credit Score?
Applying for and getting a subprime loan doesn’t hurt your credit score any more than the average loan. As far as your credit score is concerned, there is nothing different about a subprime loan versus a prime-rate loan. Your score is affected the same way either way.Any time a lender runs a hard credit check during a loan application, your credit score is hurt a few points. But making loan payments on time can help you build credit.The largest contributor to a person’s FICO credit score is their payment history. It accounts for 35% of a person’s total score, and is why making your payments on time is so important. Paying down your loan will gradually lower your amount owed (which accounts for 30% of your FICO credit score). Over time, a subprime borrower may be more likely to qualify for a prime-rate loan, as long as they have paid their bills on time and paid down their debt.
How Do Subprime Loans Work?
What is subprime lending? Many lenders offer subprime loans — they’re not unusual. You can get a subprime mortgage, subprime auto loan, or subprime unsecured personal loans. Shopping for subprime loans is simple. Use a loan broker platform and enter your credit score, ZIP code, and how much you want to borrow. From there, you’ll receive a list of lenders who are willing to work with borrowers who have a similar credit portfolio.Once you formally apply, you’ll be given more specific loan terms. From there, compare personal loan rates and repayment periods. You may even want to make a subprime personal loans list of all your favorites. Depending on which type of loan you need, you may be required to put down a large down payment. For example, if you need a subprime auto loan, subprime borrowers typically need to put down a larger percentage of the purchase price than borrowers with good credit.Once you’ve been approved for the loan, the repayment process is the same as any other loan product, but you will be paying more than someone who borrowed the same amount but has better credit. With subprime loans, origination fees, and interest are usually higher than a standard loan.You may also have a longer repayment period, which has its own set of benefits and drawbacks. Generally speaking, a longer repayment period lowers your monthly payment, but it also increases the overall cost of the loan because interest accrues over a longer period of time. Keep in mind that subprime can mean different things to different lenders. Your credit score isn’t the only thing that may cause a lender to think of you as a subprime borrower. Other contributing factors include your income and collateral.
4 Types of Subprime Loans
There are a few different types of subprime consumer loans, each having its advantages and disadvantages:
1. Interest-Only Subprime Loans
At the beginning of an interest-only subprime loan, your payments are only going toward interest. Therefore, while your monthly payments are small, you’re not actually paying down the loan because you're essentially just paying lender fees. When you’ve finished paying off the interest, all payments go toward the loan’s principal. Unfortunately, the monthly payment amount increases once this shift occurs.
2. Fixed-Rate Subprime Loan
With a fixed-rate subprime loan, the interest is the same throughout the life of the loan, which means your monthly payments are always the same. The downside to this is that the repayment period can be as long as thirty or more years. While this lowers the monthly payment amount, it increases the amount you’ll pay in interest over the life of the loan.
3. Adjustable-Rate Subprime Loan
For the initial duration of an adjustable-rate subprime loan, interest rates remain fixed. However, rates become variable after the initial fixed-rate period. Consequently, your monthly payments can change as the market fluctuates, which means you don’t know in the beginning how much you’ll actually pay for the loan. The frequency of payment amount changes depends on the type of loan you choose. Adjustable-rate loans can change every month, quarter, year, three years, or even five years, depending on how the loan is structured.
4. Dignity Subprime Loan
Dignity subprime loans require borrowers to put down 10% of the loan amount in order to qualify. The borrower must agree to higher interest rates during the initial repayment period, after which the interest rate lowers to a prime rate if the borrower has made regular, timely payments.For comparison, here is a breakdown of the pros and cons of each subprime loan type:
Loan Type
Advantages
Disadvantages
Interest-only subprime
Early payments are more affordable.
Once the interest is paid, monthly payment amounts increase dramatically
Fixed-rate subprime
Interest amounts stay the same throughout the life of the loan. Monthly payments stay the same. Monthly payments are more affordable for many borrowers.
Longer repayment periods mean borrowers pay more overall.
Adjustable-rate subprime
Interest rates stay the same for the first part of the repayment period.
Interest rates vary after the introductory period, which can make budgeting difficult.
Pros and Cons of Subprime Loans
Knowing the positives and negatives about subprime loans will help you make a smart financial decision.For instance, as mentioned, the interest rates on subprime unsecured personal loans are high. Borrowers with bad credit will likely get a rate near the high end of a lender’s range, which could be 35.99% or higher. That means if you took out a loan for $10,000 with a rate of 35.99% and a repayment term of seven years, you’d pay $17,489.90 in interest. However, if you qualified for an interest rate of 9.95% for that same loan, you’d pay $3,923.30 in interest. As you can see, the difference is substantial.With some financial care, someone who qualifies only for a subprime loan may be able to improve their financial situation, enhance their credit history, boost their credit score, and qualify for a prime-rate loan in the future.
Pros of Subprime Loans
Cons of Subprime Loans
May improve credit score and credit history over time.
Because of high interest rates, the overall cost of subprime loans is higher than prime-rate loans.
Provides funding for borrowers that are unable to qualify for other loan products.
Income requirements of lenders can be more difficult because the monthly payments are higher than average.
Subprime Personal Loan Lenders
Personal loan approval is never guaranteed, but here are some lenders that may offer online personal loans to borrowers with subprime credit. (The following information on APR range, loan amounts, and maximum term lengths will be updated weekly, every Monday.)
Step 1: Start by checking your credit score. Many banks offer their account holders free updates on their credit score. Step 2: Determine how much you need. Many subprime lenders have specific ranges of loan amounts. Knowing what you need will determine which lenders may be willing to work with you.Step 3: Calculate your annual income. Lenders typically want to know your pre-tax (or gross) income. Use tax returns and pay stubs to calculate how much you make.Step 4: Gather the appropriate documentation and information. You may be asked for the following:
Government-issued ID.
Tax returns.
Pay stubs.
Social Security number.
Employer name.
Start date of current job.
Amount of recurring debts.
Step 5: Apply online. A loan broker can speed up the application and rate comparison process by only requiring one application. Step 6: Compare rates and loan terms. When comparing loan products, look at the following information provided by each lender:
Step 7: Choose the lender offering the best loan product for your specific financial needs. By comparing the above loan terms, choose a personal loan that fits within your budget the best. Don’t just look at interest, but also pay close attention to fees, such as the loan origination fee. For example, one company may offer a slightly lower APR, but when you take into account the loan origination fee, it actually becomes more expensive than other options.
Subprime Loans vs Regular Loans
Subprime personal loans and regular personal loans share some of the same characteristics. But they also have some key differences that it’s important to be aware of:
Similarities
Both subprime personal loans and regular personal loans allow you to borrow money that you repay with interest in installments over a set period of time. Both types of loans can affect your credit. As long as you repay these loans on time consistently, they may help build your credit.
Differences
Subprime loans have higher interest rates than regular loans. They also come with higher fees, such as origination fees, and borrowers might be limited to smaller loan amounts. The repayment period for subprime loans is often longer, which can make your monthly payments smaller, but you’ll pay more in interest over the life of the loan.This chart gives you an at-a-glance comparison of the pros and cons of subprime loans vs. regular loans.
Subprime Loans
Regular Loans
Pros
• Provide access to funds for those with poor credit• May help build credit score and credit history with consistent on-time payments
• Lower rates than some other lending products• Higher borrowing limits
Cons
• High interest rates and fees• Smaller loan amounts
• Eligibility requirements can be difficult for some borrowers to meet• May include penalties such as prepayment penalties
Alternatives to Subprime Personal Loans
Knowing when to consider subprime personal loans is sometimes half the battle. When it doesn’t feel right, consider the following alternatives:
Getting a Cosigner
Cosigning on a personal loan can dramatically improve your chances of getting a prime-rate loan if your cosigner has a strong income and credit score. The downside, however, is that if you miss payments, both of your credit scores will be hurt because both of your names are on the loan.
Borrowing From Friends and Family
Sometimes, a loan from a formal financial institution is not the answer. Asking a friend or family member for a loan may be a solid alternative. By signing a promissory note or loan agreement, you can put your lender at ease, knowing you’re serious about paying them back.
Selling Assets
Sometimes we overextend ourselves and purchase things that are difficult to afford long term, such as an expensive car. If you have a financial emergency that requires immediate funding, consider selling some of your assets and using the proceeds to fund whatever it is you were considering a loan for.
Pay by Cash
If you have the money in savings, but are considering a subprime loan to improve your credit, it may make more sense to pay by cash and take your time improving your credit score by other means. After all, a large portion of your credit score revolves around how much debt you have. If you increase your debt by a significant amount, the benefits of the subprime loan may be marginal.
Home Equity Loan
If you own your home and have accrued enough equity in it, you may be able to qualify for a home equity loan. Unlike subprime unsecured personal loans that require no collateral, with a home equity loan, any equity you have is used as collateral to secure a second loan.
Compare Personal Loan Lenders
Borrowers with subprime credit scores below 600 may qualify for personal loans. Lantern by SoFi can help you find online personal loans whether you have good or bad credit. Just provide basic information about yourself and the loan you need, and Lantern can guide you in the process to apply for a personal loan with the lender of your choice.Whether you are simply looking for a $2,000 loan or a personal loan for an emergency, Lantern can help you find a lending solution.Compare personal loan rates and apply in minutes.
Frequently Asked Questions
What is a subprime personal loan?
Do subprime loans still exist?
What credit score is needed to qualify for a subprime loan?
Photo credit: iStock/Sezeryadigar
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About the Author
Lauren Ward
Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
