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What is a Subprime Auto Loan

If you are struggling with poor credit and need a car, you will probably experience some difficulty taking out a regular auto loan. However, you might still be eligible for a subprime auto loan if all other avenues are closed to you. While these come with a few disadvantages, a subprime loan would allow you to purchase a vehicle if you needed one immediately.

What Is a Subprime Auto Loan?

Sub-prime auto loans target low-income or poor credit buyers who often might not receive approval for an auto loan. While the exact range of what is considered a subprime credit score can vary, credit scores in the “fair” to “average” range between 580-619 typically qualify as subprime. Subprime credit makes you a higher-risk borrower, and subprime loans come with much higher interest rates as a reflection of this.  

While most people utilize subprime loans to purchase vehicles, they can also finance mortgages and other significant investments for high-risk individuals and businesses. Subprime loans came into fashion in the early 2000s and fell off following the Great Recession of 2008 but are beginning to see a resurgence in recent years.

How a Subprime Auto Loan Works 

Applying for a subprime auto loan is no different than applying for any other type of loan. Simply pick your financial institution, apply online or in person, and be ready to provide some personal information alongside your essential financial documents. Subprime lenders offer loan to people who would otherwise have their loan applications denied, so expect higher interest rates and fees in exchange for this accessibility.

How Credit Scores Affect Car Loans 

Your credit score directly impacts what type of car loan you may be eligible for. The higher your credit, the lower the interest rate on your loan can be. People with poor or subprime credit are assessed much higher interest rates and can even see their loan applications outright denied. These precautions exist because financial institutions see subprime borrowers at greater risk of delinquency on their loan payments.  

If you have poor or no credit, you might still be able to borrow money for a vehicle using a subprime loan. Not only would you see exponentially higher interest rates with a subprime loan, but your loan agreement will likely come with more restrictive terms and a possible slew of additional fees.

What Is Considered a Subprime Auto Loan? 

A subprime auto loan is any loan made to an individual whose credit is considered subprime. There is no official subprime credit score or relative auto loan rate, but subprime credit tends to fall somewhere in the 580-619 range. These calculations vary between institutions and lenders.  

The vehicle type, old or new status, and the loan term can also affect whether a subprime loan is in order.  The average APR on a new car loan is somewhere between 3.65% to 4.28%, whereas average subprime loans for a similar vehicle would be around 11.92% to 14.39%.  In some cases, the APR on a subprime auto loan can be upwards of 29%.

Do Subprime Loans Hurt Your Credit?

Subprime auto loans have the potential to hurt your credit score, just as any loan could come back to bite you in the long run. Payment history is the primary determining factor in a person’s credit score. Paying your bill on time can prove difficult with subprime loans due to the elongated payment period and higher premiums resulting from exponentially higher interest rates.

Having a higher credit balance also negatively affects your credit score. The higher your interest, the longer it should take to pay down your loan balance. This is especially relevant if your subprime loan has any prepayment penalties attached to it.

Average & Subprime Auto Loan Rates 

Just as there exists no exact definition of a subprime credit score, there is no constant subprime auto loan rate. Various factors affect auto loan rates, such as a vehicle’s new or used status, the type of vehicle, and the terms of your loan. Listed below are what you can expect to see from both standard and subprime auto loan rates:

Standard Auto Loan Rates 

These vary depending on your credit score, but the standard auto loan rate for someone with good credit is around 3.51% interest for a new car and 5.38% for a used car. Prime credit typically falls between the 661-780 range. Near-prime credit (601-660) and superprime credit (781-850) are also favorable credit ranges, and each would see a respective rise or dip in interest rates.

Standard auto loans are typically free from the additional fees and restrictive terms that often come with subprime loans. The average car loan term is around 72 months, and your monthly payment would be notably lower with a standard auto loan than with a subprime one.

Subprime Auto Loan Rates 

Subprime auto loan rates are dramatically higher than standard loan rates. Lenders view subprime borrowers as high-risk clientele and charge accordingly. Average interest rates for a subprime auto loan on a new car are 9.41% and around 15.96% for a used car–about three times higher than standard rates.

Once your credit score dips under 500, you begin falling into what is called deep subprime credit.  Average deep subprime interest rates are between 19.87% and 29%. Subprime auto loans might also come with fees you might not traditionally expect. Subprime lenders may even assess a prepayment fee for paying off the loan too early, locking you into a set amount of guaranteed payable interest.

What Are the Risks of a Subprime Auto Loan? 

While taking out a subprime auto loan might be the only means some people have of acquiring a vehicle, these come with obvious risks. Not only can interest rates be astronomical, but the associated fees can also prove problematic. Unmanageable interest rates put you at higher risk of defaulting on your loan, which could lead to vehicle repossession.

High-Interest Rates 

Subprime auto loans tend to come with a heftier APR than regular auto loans because the lender sees you as a risk and is therefore covering their end. APR stands for annual percentage rate and represents the interest rate of your loan at a yearly rate. Generally speaking, the higher the APR on a loan, the higher your monthly payment should be.

Looking at your APR is the best way to get a sense of what you’ll be paying over the long term. The more you pay in interest, the more you pay over the entire life of your loan. This interest can amount to thousands, if not tens of thousands of dollars, depending on the situation. Vehicle-reliant individuals with poor credit are especially vulnerable to the trappings of subprime interest, as they don’t have a leg to stand on when negotiating their loan terms.

Extra Fees

Not only do subprime loans require higher monthly premiums, but subprime lenders also tend to write additional fees into their loan contracts.  These can include, but are not limited to:

  • An origination fee, which is a processing fee for initially taking out the loan
  • A prepayment fee for paying off the loan too early.  This locks you into paying a certain amount of high interest no matter how you decide to pay off your loan.
  • A service contract for general maintenance and repairs

When considered alongside all the other daily expenses of car ownership (e.g., state taxes, title fees, insurance) and the high-interest rates associated with subprime loans, these extra fees pile onto what might already be a troublesome financial burden.  

Risk of Default and Repossession 

Sub-prime loans are at higher risk of default than a prime or near-prime auto loan. Payment plans on these loans are more challenging to manage due to all the excess interest, and defaulting on your loan could eventually lead to your lender repossessing your vehicle as collateral. Reselling the car they helped you buy is just one way of recouping a loan you’re incapable of paying back.

Loan Default and vehicle repossession could have long-term financial consequences.  Individuals who have seen their vehicles repossessed are more likely to declare bankruptcy.  A repossession is also a black mark on your record, making it that much harder to apply for credit later in life.  

Working Around a Subprime Auto Loan 

In conclusion, there are more financially advantageous methods of purchasing a vehicle than through subprime auto loans. These should only be resorted to if you need a car right away and have no other avenues toward a loan. If you have no choice but to utilize a subprime loan, you should still shop around for the best subprime rates available. Every lender abides by a different set of criteria, and rates can vary widely–sometimes even proving the difference between 10% APR and 29% APR. Make sure to do your homework.

If you have the luxury of time, make an effort to improve your credit score or start a credit history.  Begin by making small purchases on a credit card and paying them off in total and on time. The more available credit and timely payments you have in your name, your credit score will be higher. Higher credit will help you negotiate a better auto loan with lower interest, saving you a lot of money in the long run.