Should you seek out a subprime auto loan?

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Ask a Lender
November 17, 2017 | Updated November 20, 2017


Key Points

What to watch for when considering a subprime auto loan

  • Auto lenders often classify credit scores of 620 and below as subprime.
  • Having little to no credit, or past delinquencies or bankruptcies, may disqualify you from a traditional auto loan.
  • Expect to pay a higher interest rate, a higher down payment or need a co-signer.
  • You may qualify if you have sufficient income and a low amount of debt.

Subprime auto loans can generally be defined as those given to borrowers with less-than-average credit scores, or little to no credit history. Because the lender is assuming additional risk, these loans typically have higher interest rates and are more likely to include prepayment penalties. They were popular products prior to the Great Recession but are now relatively difficult to find as lenders have enacted more stringent credit requirements.

Although there is no universal credit-score threshold for subprime borrowers, scores of 620 and below often don’t qualify for traditional auto loans. The Federal Reserve Bank of New York estimated there were 23 million consumers with subprime auto loans in the U.S as of third-quarter 2017. Many of these loans were obtained through alternative, nonbank financing sources, and the 90-day delinquency rate of 9.7 percent on these types of loans were more than twice the delinquency rate of 4.4 percent on loans through traditional banks.

So, what should you do if you’re in need of a vehicle but can’t qualify for an auto loan with good terms?

Subprime lenders

Although there are millions of subprime auto loans on the market, many lenders seem to be more restrictive about these types of loan originations. According to a first-quarter 2017 report from Experian, one of the major credit-reporting agencies, the number of auto loans issued to subprime and deep subprime borrowers are at a 10-year low, dropping 8.6 percent from the previous quarter. Subprime borrowers are defined as having credit scores of 600 and below, while deep subprime borrowers have scores of 500 and below.

A poor credit score isn’t the only reason a lender might reject your auto-loan application. People who have yet to establish credit in the U.S. are commonly turned down. Anyone with a history of late payments, delinquent accounts, bankruptcies and even identity theft or divorce might be a red flag to a lender.

There are also several things you can do to strengthen your financial profile and make it more attractive to an auto lender.

First, verify your credit score through FICO or another credit-reporting agency. Don’t assume that you have a subprime score because you’ve made late payments on other accounts or have had other loan applications rejected. You may also have errors on your credit report that are negatively impacting your score. If you can, delay your car purchase until you can rebuild your score. This may include clearing up errors or paying off any accounts in collections.

Before heading to the dealership, find a lender that will preapprove an auto loan for a specific amount. This may give you leverage during the purchase process. Most dealerships have experience with subprime borrowers, however, and will be able to connect you with the right lending institution.

Pros and cons

If you have to turn to a subprime auto lender, be prepared to pay for your borrowing privileges. First-quarter 2017 numbers from Experian show that subprime borrowers paid an average interest rate of 16.48 percent for an auto loan, compared to an average rate of 5.29 percent for a prime borrower with a score between 661 and 780. On a five-year loan of $16,000, that equates to about $5,500 in additional interest charges for the subprime borrower.

When approaching a subprime auto lender, be prepared to accept a higher interest rate. You may also be required to make a sizable down payment of up to 20 percent, or have a co-signer with good credit.

By itself, a subprime credit score may not disqualify you from financing options. If you have sufficient income and a relatively low debt-to-income ratio, a lender may approve you based on your ability to repay the loan. Having low income, high amounts of debt or a vehicle repossession in the past year, however, may disqualify you.

Although higher down payments on subprime auto loans may be viewed as a negative, this also results in a smaller loan amount that’s closer to the true value of the vehicle once you drive it off the lot and it depreciates. If possible, keep the loan term to four years or less as that will reduce your interest payments and the vehicle will be less likely to need costly repairs before the loan is paid off. Finally, be wary of accepting a loan with a prepayment penalty or a mandatory arbitration clause, which prohibits you from settling a dispute with the lender in court.

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