Prime vs Subprime loans: how are they different


SAN JOSE, California, February 2, 2021 / PRNewswire / – FICO® scores are one of the key metrics that many lenders use to assess a borrower’s creditworthiness. For this reason, your credit score can affect not only your chances of loan approval, but also the rates and terms you are offered. The following is what you need to know about prime and subprime loans and how they are different from myFICO.

For more information on loans and credit, visit the myFICO blog at https://www.myfico.com/credit-education/blog

The different ranges of FICO® scores to which borrowers may belong are often described as “prime” or “subprime”. Borrowers with the highest FICO scores may be offered first-rate loans, while borrowers with bad or damaged credit may only benefit from subprime loan options.

But what exactly do these terms mean? Let’s take a closer look at prime and subprime loans to help you understand their differences and what you need to know before taking out a subprime loan.

What does it mean to be a primary or subprime borrower?

Blue chip borrowers are considered the least likely to default on a loan. Subprime borrowers, on the other hand, are considered to have higher risks of default due to their limited or damaged credit history.

Lenders use multiple ranges of FICO® scores to categorize loan applicants. Consumers with scores in the upper range are the most privileged (or “super-prime”), and borrowers in the lower range are considered “deep subprime”.

The premium and subprime credit rating ranges used may vary by lender. For example, some lenders may use the following FICO® score ranges:

  • Super-prime (FICO scores of 720 or higher)
  • Bonus (FICO scores 660-719)
  • Near the premium (FICO scores 620 to 659)
  • Subprime (FICO scores 580 to 619)
  • Deep subprime (FICO scores less than 580)

To learn more about the FICO® Scoring Ranges and why they are important, take a quick look guide.

Prime vs Subprime loans: how are they different?

The biggest difference between subprime loans and subprime loans is usually the interest rates they charge. It is generally considered riskier to lend to borrowers with poor or limited credit histories, so lenders charge higher rates to compensate for this risk.

A recent study by Colombian Business Law Review found that subprime auto loans can have interest rates above 29%. And the CFPB has found that personal payday loans, which subprime borrowers can turn to as a last resort for financing, can charge fees that translate into annual percentage rates (APRs) of nearly 400%.

There may also be other differences. Prime loans, for example, can be offered for larger loan amounts. Subprime loans, on the other hand, may require larger down payments or higher origination fees.

Best and Worst Loan Options for At-Risk Borrowers

It is possible to get a loan even if you have a FICO® subprime score. But not all subprime loans are created equal. Here are some of your best and worst options for a variety of loan types.

Personal loans

If you need the cash quickly, it can be tempting to visit a payday loan company or other lenders that offer short term personal loans without credit checks. But some of these loans may not be in your best interest. And many of these loans can come with fees and / or interest rates so high that borrowers can easily get trapped in a cycle of debt.

You may be able to avoid these types of loans by taking out a Alternative Payday Loan (PAL) a local credit union. As a rule, these loans do not come with fees greater than $ 20 in fees and have maximum interest rates of 28%. PALs come in the form of loan amounts of $ 200 at $ 1,000 and durations of one to six months.

Auto loans

Some car dealerships offer in-house financing that can be aimed at borrowers with at-risk FICO® scores. In fact, some of these “Buy Here, Pay Here” dealers proudly advertise their “No Credit, No Problem” policies. But these loans can come with higher interest rates. And, in some of the worst cases, you can pay more than the actual value of the vehicle by choosing these “Buy Here, Pay Here” dealership financings.

But you may have better options. Before you start the car buying process, see if you can get pre-approved for a loan with a lender, bank, or a credit union. In some cases, you might be able to get a much better deal with a third party lender than the dealership’s internal financing option.

Credit unions can be a particularly effective way to find low auto loan rates. According to the National Credit Union Administration (NCUA), the average 48-month loan for a used car in the third quarter of 2020 was 2.08 percentage points lower at credit unions than at banks. And credit unions were also better on 48-month new car loan rates, averaging 1.80 percentage points.

Related: What credit score do you need to buy a car?

Mortgages

In the early 2000s, subprime mortgages were fairly easy to find. Many mortgage lenders not only accepted low borrowers FICO® scores but also failed to verify that borrowers had sufficient income to make their loan repayments.

The end result of these practices was the mortgage crisis and recession of 2008. Mortgage companies are now more regulated and must follow stricter underwriting standards. However, subprime mortgages are still available. Often times, these loans come with adjustable rates, which means they can increase dramatically over time.

However, subprime borrowers looking to purchase a home that will be their primary residence may be able to take out an FHA fixed rate home loan. Borrowers can claim a FHA loan with FICO® scores as low as 580 and down payments as low as 3.5%. And if you are able to put 10% less, the minimum FHA FICO score can be as low as 500.

VA and USDA loans are two other government insured home loans that have lenient credit requirements. But it’s important to note that while subprime borrowers can get approved for a mortgage loan through these programs, they are unlikely to qualify for the best rates available. See How Your FICO Score Could Affect Your Mortgage Rates.

Are subprime loans worth it?

There are times when it is just not practical to wait to qualify for prime loans. For example, you may need to buy a car right away so that you can continue to commute to work every day.

And, in emergencies like these, taking out a subprime loan might make sense. But even when it is necessary to take out a subprime loan, you will still want to shop around to several lenders to compare rates and terms.

In other situations, it may be better to wait to take out a loan until your FICO® score improved. This could be especially true for large loans like mortgages, where even a slight difference in interest rates can have a significant impact on how much you pay over the life of the loan.

Remember that the information in your credit reports is constantly updated, as are your FICO® scores. Next strong credit habits over time, a subprime borrower can become a primary borrower. Learn more about the factors that affect your FICO scores.

About myFICO
myFICO makes it easier to understand your credit with FICO® Scores, credit reports and alerts from the 3 bureaus. myFICO is the consumer division of FICO – get your FICO scores from the people who do the FICO scores. For more information visit https://www.myfico.com.

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