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Subprime auto loans: How do they work?

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Subprime auto loans are car loans for drivers whose poor credit classifies them as “subprime” borrowers. They have higher interest rates and more restrictions than other auto loans.

Anna Swartz 1600

Anna Swartz

Published June 10, 2019

KEY TAKEAWAYS

  • A subprime auto loan is an auto loan for borrowers with poor credit

  • Subprime auto loans tend to have higher interest rates and more rules and restrictions than standard loans

  • It’s best to avoid subprime auto loans if you can

Your credit score is one of the most important factors that lenders take into account when you apply for an auto loan, so having a poor credit score can make buying a new or used car difficult. But having bad credit doesn’t mean you can’t get a loan to buy a car — a subprime auto loan is a type of car loan for borrowers whose low credit score classifies them as subprime.

Subprime loans differ from conventional auto loans in a few key ways. They’ll usually have higher interest rates and more restrictions than those for drivers with good or excellent credit. To get a subprime loan, you may be required to put down a larger down payment than you would if your credit score were higher. In general, it’s best to avoid subprime auto loans if possible.

In this article:

What is considered a subprime credit score?

A credit score is a composite, three-digit number that lenders use to judge your trustworthiness as a borrower. Your credit score is based on your credit report, but there are actually multiple credit bureaus that generate those reports. There are also multiple scoring models used to calculate your credit score. This means that while you may think your credit score is just one number, you actually have many.

You credit score is calculated based on several main categories, including your payment history, or whether you make bill and loan payments on time, your credit utilization, which is the percentage of your available credit that you’re using and the length of your credit history, meaning how long your accounts have been open.

Credit scores range from 300 to 850. Different institutions use slightly different scales to rank scores, but in general, credit scores are ranked as follows:

  • 800 to 850 = exceptional
  • 740 to 799 = very good
  • 670 to 739 = good
  • 580 to 669 = fair
  • 300 to 579 = very poor

The category you fall into will determine the loan offers you get. Borrowers with the highest credit scores will get the lowest interest rates and best terms. The lower your score, the harder it will be to secure an attractive auto loan. A score below 669 will likely put you in the subprime category.

You may wind up as a subprime borrower if you’ve missed multiple payments, if you’ve declared bankruptcy or had a recent foreclosure, or if your debt-to-income ratio is too high.

What does a subprime auto loan mean?

In general, it’s wise to avoid subprime loans. Subprime loans have higher interest rates than standard loans — that’s because subprime borrowers are considered to be at a higher risk of defaulting on a loan, so the lending institution charges them more to balance out that risk. Subprime auto loans may also require larger down payments, which is money you put down on a car up front, for the same reason.

Subprime car loans may also have long loan terms, which is the amount of time you have to pay off a loan. Longer terms can help lower monthly payments, but you’ll likely wind up paying more over the full life of the loan.

Subprime loans will often come with extra fees, like fees for taking out the loan to begin with, or a prepayment penalty for paying off the loan early. Because subprime borrowers are considered riskier, subprime auto loans may have less tolerance for late payments. All of this means that subprime borrowers will pay more over the life of their loan than borrowers with higher credit.

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Where can I get a car loan with bad credit?

If you have poor credit, you may only be offered a subprime loan, either through a bank or credit union or through a lender that specializes in borrowers with poor credit. But if you can, it’s best to avoid subprime loans. They’re costly, and some lenders may offer you subprime loans that you’re unlikely to be able to keep up with, putting you at risk for defaulting and losing your car.

If you have credit that places you in the subprime category, take steps to ensure you’re getting the best loan offer possible, including:

  • Budgeting out your monthly payments. Figure out how much you can afford to spend each month and stick to it. If you can’t finance the car you want within that budget, consider looking at older or more affordable models.

  • Work with a lender you know. A bank or a credit union where you already have accounts may be more likely to work with you on getting a better auto loan.

  • Shop around. Don’t settle for the first loan offer you get. Shop around and compare offers so you can be sure you’re getting the best possible terms.

  • Consider delaying your purchase. If you can, put off purchasing a car while you focus on raising your credit by making payments on time and paying down debts. You should also look over your credit report regularly and dispute any inaccuracies you see.