Over a third of Americans have a credit score that is considered less than prime. And that's bad news for borrowers who are looking to save money when they borrow money as credit lines extended to subprime borrowers frequently come with steep costs.
"The biggest issue with a subprime loan is usually the interest rate,"Jim Triggs, president and CEO of nonprofit credit counseling agencyMoney Management International, Inc(MMI), tellsSelect.
Subprime borrowers have lower credit scores than prime borrowers, and financial institutions worry they'll be at higher risk of defaulting on their payments. As a result, banks typically charge subprime borrowers higher interest rates and sometimes additional fees.
"For example, subprime marketplace lenders (online personal loan lenders) can charge upwards of 30% for a personal loan," Triggs says, noting that consumers with low credit scores are often taken advantage of due to their financial circ*mstances. "Obtaining loans such as these could put struggling consumers into a much deeper hole than they were prior to obtaining the subprime loan."
There are steps subprime borrowers can take to protect themselves from subprime loans, including brushing up on their financial education and reading the fine print.
Knowing your credit score can help protect you
One of the best ways a consumer can protect themselves from high-risk loans and credit cards is by knowing their credit score.
There are five different categories of borrowers, ranging from deep subprime to super-prime. While credit scoresrange from 300 to 850, those who fall into the subprime or deep subprime categories have scores on the lower endof the spectrum.
The credit bureauExperian classifies subprime borrowers with FICO credit scores between 580 and 669. Meanwhile, the Consumer Financial Protection Bureau (CFPB) Consumer Credit Panel defines subprime borrowers as those with credit scores between 580 and 619. Deep subprime consumers have credit scores that fall below 580.
AGOBankingRates 2019 survey found that nearly 40% of Americans don't know their credit score. It's important to be aware of where your credit stands because it impacts the kinds of loans and credit cards you will qualify for.
According to Tiffany Aliche, a financial educator and founder ofThe Budgetnista, you should aim for a credit score above 700 and ideally above 750 to get the best interest rates.
"Be patient and do not purchase before being ready," Aliche tells CNBC Select. She advises that consumers really take a look at the different interest rates being offered. "Understand just how much money you'll pay out if you have a lower credit score."
There are many ways you can check your credit score for free, including using resources likeCreditWise from Capital One,Chase Credit JourneyandDiscover Credit Scorecard (only available to Discover cardholders). You don't have to be a cardholder to check your score using these sites. And having a low credit score isn't a life sentence— there are steps you can take to improve it.
Have a plan to repay your debts
On top of knowing your credit score, it also helps to be able toclearly show that you have the ability to repay a loan or line of credit extended to you. If you already have a credit card, make sure you pay all your monthly bills on time and, if possible, in full, so you can show lenders you have a healthy track record of timely payments.
And if you're looking for a credit building credit card, be sure to review the terms and conditions carefully. Some subprime cards can charge high fees alongside high interest rates. A better option is asecured credit card,like the Capital One Platinum Secured Credit Card and the Citi® Secured Mastercard®. You pay a security deposit upfront that acts as your credit limit. Once you use this card for a while, you can be upgraded to an unsecured card and get your deposit back.
Bottom line
Subprime loans can put you in a very difficult cycle to break: If you're struggling to repay high-interest debt, you're at risk for falling behind on your payments. And since your payment history is the most important factor in your credit score, missing payments can further damage your credit.
"One should avoid high-interest subprime auto or personal loans if they possibly can," says Triggs.
Alternatives to subprime loans include borrowing from friends or family, getting a co-signer to help you get a loan or credit card, or selling assets. In the meantime, work on improving your credit and building an emergency savings to help prevent the need for loans in the future.
Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
FAQs
Subprime (credit scores of 580-619) Near-prime (credit scores of 620-659) Prime (credit scores of 660-719) Super-prime (credit scores of 720 or above)
How can a credit score impact a loan that you might receive? ›
The riskier you appear to the lender, the less likely you will be to get credit or, if you are approved, the more that credit will cost you. In other words, you will pay more to borrow money. Scores range from approximately 300 to 850.
How does your credit score being high or low affect your ability to secure a loan for things such as a car or a house? ›
Lenders view your credit score as a numerical representation of how likely you are to repay a loan. The higher your credit score, the less risk lenders think you pose. This means that you are more likely to receive more favorable interest rates and better terms.
Why you should protect your credit and credit score? ›
A poor credit score can not only affect the terms of financing you may receive, including interest rate, it can also prevent you from getting a loan or new line of credit altogether.
What makes someone a subprime borrower? ›
A subprime borrower is someone considered to be a relatively high credit risk for a lender. Subprime borrowers have lower credit scores and are likely to have multiple negative factors in their credit reports, such as delinquencies. They may find it difficult to obtain credit, especially with favorable terms.
What is a subprime credit example? ›
A subprime borrower is anyone who doesn't have good enough credit to qualify for a creditor's prime rates and terms. You might be a subprime borrower if you: Recently missed payments on credit accounts. Had a recent charge-off, repossession or foreclosure.
Why are credit scores important? ›
Companies use credit scores to make decisions on whether to offer you a mortgage, credit card, auto loan, and other credit products, as well as for tenant screening and insurance. They are also used to determine the interest rate and credit limit you receive.
How does credit score affect loan rates? ›
Generally speaking, borrowers with credit scores of 760 or higher get charged the lowest interest rates. On conventional conforming loans, which must adhere to Fannie Mae and Freddie Mac guidelines, a 780 may qualify you for a slightly lower rate—though it depends on your down payment amount.
Why is credit rating important? ›
A credit score indicates an individual's credit health. This indicates whether the individual can undertake a certain loan, as well as their ability to repay it, helping to gauge the level of risk attributed to an individual when it comes to repaying a loan.
Is a 900 credit score possible? ›
While achieving a CIBIL Score of 900 is technically possible, it is extremely rare. Scores above 760 are considered very good or exceptional, providing significant benefits such as lower interest rates and higher chances of loan approval.
Poor credit can make it harder to get car and home loans, and to qualify for a regular credit card—you may need to start off with a secured credit card to build your credit. Even if you are offered a loan, chances are it will be at a higher interest rate.
How does credit play a positive and negative role? ›
Credit plays a vital and positive role as :
(i) Credit helps people from all walks of life in setting up their business, increase their income and support their families. (ii) To some people, loan helps a lot in constructing their houses and get relief from monthly rent.
Why is knowing your credit report important? ›
Highlights: Checking your credit history and credit scores can help you better understand your current credit position. Regularly checking your credit reports can help you be more aware of what lenders may see. Checking your credit reports can also help you detect any inaccurate or incomplete information.
Why is credit protection important? ›
Credit insurance protects your credit rating and reduces financial burden by paying off or reducing your remaining loan balance in the event of your disability or death.
Why is credit risk the most important? ›
Preservation of Capital: Effective credit risk management ensures the preservation of capital by reducing the likelihood of loan defaults. By identifying and managing credit risks, banks can protect their balance sheets and maintain the stability of their operations.
Who qualifies for a subprime loan? ›
Subprime vs. prime mortgage requirements
| Credit score | Down payment |
|---|
| Prime mortgage requirements | 700+ | As low as 3% |
| Subprime mortgage requirements | > 560 | As much as 25%-35% |
Apr 15, 2024
For example, according to Experian, the two tiers of subprime auto loans include "subprime loans" for credit scores 501 to 600 and "deep subprime loans" for credit scores 300 to 500. These auto loan tiers are based on the FICO scoring model, which assigns credit scores that range from 300 to 850.
What credit rating is subprime mortgages? ›
The interest rate associated with a subprime mortgage is usually high to compensate lenders for taking the risk that the borrower will default on the loan. These borrowers typically have credit scores below 620 along with other negative information in their credit reports.
