Definition and Examples of a Subprime Lender
Subprime lenders are lenders that offer loans with higher interest rates to subprime borrowers because they are considered a higher risk. The two main types of interest rates are prime and subprime. Prime rates are offered to borrowers who have higher credit scores and clean repayment history. Subprime rates, which are usually significantly higher, are offered to borrowers who, for example, have lower credit scores, a lack of proof of income, or have had a bankruptcy or foreclosure. Financial characteristics of high-risk borrowers may also include:
Bankruptcy in the last five years High debt-to-income ratio Two late payments over 30 days in the last 12 months or one late payment over 60 days in the last 24 months
Subprime lending practices are fairly common with mortgages and auto loans.
Subprime Mortgages
A subprime lender offers potential homebuyers mortgages that have significantly higher interest rates than the average interest rates. For example, mortgage rates for a fixed-rate, 30-year loan were about 2.9% in September 2021. A buyer with excellent credit may get near that rate from a traditional lender, but a borrower with poor credit history might get between 10% and 18% on a subprime mortgage.
Subprime Car Loans
Car loans from subprime lenders can add a significant amount to the total cost of the loan. For borrowers with exceptionally poor credit, or “deep subprime” borrowers with credit scores of less than 580, may face interest rates of more than 20% on a loan for a used car. Here’s how those rates compare to auto loan rates for other borrowers, according to Experian data: When a borrower cannot meet those terms, they may end up in default, and can possibly lose their home to foreclosure. Even if the subprime lender makes terms made clear to the borrower, the subprime lender may still use predatory tactics in marketing to convince borrowers to accept the loan.
How a Subprime Lender Works
If the term “subprime” sounds familiar to you, it may be because the financial crisis of 2008 included a subprime mortgage crisis. The high cost of housing and a shortage of inventory created a demand that subprime lenders were able to meet with subprime mortgages, essentially by packaging them into securities and selling them to investors. When home prices were rising, subprime borrowers and their lenders had the advantage of equity. If a borrower could not meet their obligations, the home could be sold and the lender would not experience a loss. Once home prices peaked, investors were more cautious about those securities, and, in turn, lenders became more reluctant to offer them. The end result was that housing prices fell quickly, and suddenly high-risk borrowers owned homes that were worth far less than what they paid for them, leading to a slew of foreclosures and losses for subprime lenders. Subprime loans can benefit some borrowers who have no other financing options. However, be aware that lenders may use predatory tactics to attract high-risk borrowers to agree to a loan that they may not be able to repay. In that way, subprime loans have the potential to cause more financial harm.
