What Are Subprime Auto Loans?

Subprime auto loans are written for borrowers who have low credit scores. Typically, lenders are reluctant to lend to subprime borrowers due to the fact that low credit scores are indicative of past problems with managing credit. However, some companies specialize in lending to subprime borrowers.

Subprime

People that banks view as creditworthy customers can borrow funds at a low interest rate known as the prime rate. Credit scores range from 300 to 850, and in order to qualify for prime rate loans, borrowers must have credit scores of at least 620, although many lenders require borrowers to have scores in excess of 700 to get the lowest rate loans. Consequently, people with credit scores below 620 are commonly described as subprime borrowers.

Risk

While most lenders refuse to finance cars for subprime borrowers, some lenders do write loans for these borrowers but counter the default risk by charging high interest rates. The interest rates on subprime loans are often two or three times higher than the rates available on prime loans. High rates result in high monthly payments, and therefore people who have struggled in the past to manage their finances end up having to pay more to borrow than people who have fewer money problems.

Financing

Lenders have to raise money to write subprime loans, but few banks are willing to lend funds to institutions to fund subprime lending because of the risks involved. Therefore, subprime auto lenders usually rely on borrowing money from investors. Bonds are sold against funds that contain subprime car loans and the interest payments on the loans are passed onto the bond holders as monthly bond payments. Some investors view these high yield bonds as a good alternative to more conservative income generating investment options.

Considerations

Some subprime lenders even report subprime loans to credit reporting agencies, so even if you make your payments on time, you do not improve your credit standing. If you cannot qualify for a car loan due to your credit score, you can attempt to find a co-signer with good credit who can co-sign your application and improve your chances of obtaining a prime loan. Alternatively, rather than agreeing to high loan payments, you could first try and settle your delinquent debts as doing so should improve your credit score and lower your borrowing costs.