- Subprime Lending
- Subprime lending is a category of money lending that provides loans to borrowers with bad credit. Because the borrowers are deemed less likely to repay, the loans typically carry higher interest rates than those offered to borrowers with good credit.
What is Subprime Lending?
Subprime lending is a category of lending that services borrowers with bad credit. Subprime loans typically carry higher interest rates because they are made to borrowers whose borrowing history suggests they are more likely to default. There are subprime personal loans, mortgage loans, auto loans, credit cards, and even business loans.1
When does a borrower fall into the Subprime category?
Whether you fall into the subprime category of borrowers largely depends on your credit score. The most common kind of credit score is the FICO score and it ranges from 300 to 850. Your credit score basically represents how well you’ve handled loans in the past, and the higher it is, the better you’ve done. Typically, credit scores break down into the following tiers:
As you can see from that chart, FICO scores under 630 are considered “subprime” and scores under 550 are considered “poor.”
Your credit score is a primary determiner of the types of loans you’ll be offered and the interest rate you’re charged. So, if your credit score is above 720, you’ll probably have an easy time getting a loan and the interest you’ll be charged will be relatively low. However, if your score is subprime, you’ll face two consequences: one, you’ll have a tough time convincing a lender to give you a loan; and two, if you do qualify for a loan, the interest you pay will be much higher than the rate offered to someone with better credit.
How are credit scores calculated?
Your credit score is based on your credit history, which is compiled in your credit report. Your credit report is a document that tracks your credit use over the past seven years. It details information like whether you’ve made payments on time, the balance on any outstanding accounts, and whether you’ve defaulted or filed for bankruptcy. Credit reports are maintained by the three major credit bureaus: TransUnion, Experian, and Equifax. You can request a free copy of your report from each of the bureaus once a year.2
How does Subprime Lending work?
If you have subprime or bad credit, banks and other traditional lenders are unlikely to offer you a loan. However, subprime lenders provide loans to people deemed too risky by traditional lending institutions. In order to compensate for the increased risk (as indicated by the borrower’s credit score), subprime lenders usually charge a higher interest rate.
With some personal loans, this could mean you’ll be charged an annual percentage rate (APR) above the arbitrary 36 percent benchmark. While traditional lenders might frown on charging APRs above 36 percent, these higher rates mean that loans are available to people with lower incomes and some black marks on their credit history.
Is Subprime Lending the same thing as predatory lending?
No, although there is often some overlap. Subprime lending merely refers to lenders who offer loans to borrowers with subprime credit scores. Predatory lending, on the other hand, refers to a whole host of unethical and oftentimes illegal business practices that certain lenders engage in.3
While predatory lending usually means charging borrowers excessively high rates, it can also mean using high-pressure sales tactics, misleading customers about the terms of a loan, and using short-term, non-amortizing structures that make loans difficult to repay. But there are many lenders, like OppLoans, that extend credit to subprime borrowers in a socially responsible manner.
If you have a subprime credit score and are looking for a personal loan (or a home, auto, or business loan), you should always be careful when looking at a subprime lender. Many of them, especially payday and title lenders, are indeed predatory.
So do your research: Look through the lender’s customer reviews, check out their profile on the Better Business Bureau, and always make sure to read the fine print. If you have any doubts during your loan application process, stop, ask for clarification, and hold off on signing your loan agreement until you are sure you understand the terms.
1 Pritchard, Justin. “Subprime – Definition of Subprime Borrowers and Lending.” The Balance, 8 June 2015, https://www.thebalance.com/subprime-definition-of-subprime-borrowers-and-lending-315634. Accessed 30 March 2017.