A subprime loan is primarily a type of loan offered to borrowers that don’t qualify for conventional loans and are considered high risk due to various factors such as low income, significant outstanding debt, and low credit score.
These loans can also be called bad credit loans because they are the same; that is, they are only offered to people with heightened risk factors.
What is a Subprime loan?
Subprime loans are your type of loan that is generally offered to people who have heightened risk factors such as limited credit history, low income, low credit score, etc.
Unlike a conventional loan, subprime loans have high-interest rates. Technically, most of these loans have a subprime loan counterpart, including mortgages, auto loans, personal loans, etc. However, even though there is no official credit score cutoff for borrowers, people who have a credit score below 650 usually have a more challenging time getting approved for a conventional loan. And that’s where subprime loans enter the conversation.
Of course, getting approved for a loan depends on several factors. But, the most integral part of being approved for a conventional loan is a passing credit score, which some people don’t have. If you’re just starting to build your credit, this could be disadvantageous to you since you will have a hard time getting approved for conventional loans.
That said, subprime loans were created to help those with poor credit scores to acquire a house, car, financial assistance, etc. Such loans have different features that vary from lender to lender. However, most subprime has two traits in common: higher interest rates and high closing costs.
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Types of Subprime Loans
If you’ve done your research on subprime loans, you can see that each subprime loan varies from lender to lender. But in actuality, there are three main types of subprime loans.
Subprime Home Loans
Mortgages, in reality, can be categorized into two main groups, mainly prime and subprime mortgages. Prime home loans are what you call conventional home loans that are the ones that you commonly see in the market. Subprime home loans are just prime home loans that have a slightly higher interest rate in simpler terms.
Subprime mortgages can be categorized into three main groups: adjustable rate mortgages, fixed-interest mortgages, and interest-only mortgages. Typically, subprime mortgages are only given to people who have credit scores below 650.
Subprime Auto Loans
Just like the case with subprime home loans, subprime auto loans are just your conventional auto loans, albeit with a higher interest rate. However, nowadays, it’s harder to get approved for a subprime auto loan because lenders are more strict in the assurance that the borrower will not default the loan.
To combat this uncertainty, most lenders nowadays are offering subprime loans with longer repayment periods to ensure that the borrower will repay them. Some lenders have a period that lasts for 69 months, and some go as far as 84 months.
Subprime Personal Loans
Personal loans are typically unsecured, which means they don’t require any collateral, making it risky for lenders to offer subprime personal loans for obvious reasons. You might as well opt for secured loans to have a lower interest rate instead.
Pros of Subprime Loans
Subprime loans usually have a poor image because of their higher interest rates. But they are not all that bad as there are also benefits to them. The most obvious benefit of subprime loans is that it’s easier for people to qualify for a subprime loan even though they have a poor credit score or little credit history. This means that it will be more convenient for people to build their credit if they’re just starting.
Since you can use a subprime personal loan, it will also be easier for people with bad credit to consolidate their debts, improving their credit score. This will also make their payments easier and manage their finances better. Subprime loans can also enable people who are just starting to build their credit to become homeowners or buy a vehicle when they couldn’t opt for conventional loans.
Cons of Subprime Loans
Since subprime loans carry huge risks for lenders, they counteract this by giving them higher interest rates. And the resulting scenario is the person defaulting the loan because they can’t keep up with interest.
Not only that, but subprime loans also carry a lot of fees such as processing fees, closing costs, up-front fees, etc. These can add further to your debt, which can be a real burden if you’re on a budget.
Takeaway
Subprime loans are not to be trifled with if you don’t know what you’re getting into. Before you apply for one, ensure that you have exhausted your options to get a conventional loan. Also, do your research first before taking out a subprime loan. Balance its pros and cons and ensure that you won’t be taking a huge loss in return. Lastly, subprime loans should be taken as a last resort, not your first choice.
