Car Finance

Subprime Car Finance Versus Prime Finance

By Mike Richards Updated: 09/11/2023 Posted: 04/26/2018

The term ‘subprime auto loan’ means more or less the same as ‘bad credit car loan’. However, there is a slight difference in that subprime car finance targets borrowers whose credit score may not even qualify as ‘poor’ or ‘bad’. Some don’t even make it to the credit rating range, which is between 300 to 850 points. For instance, young people just out of college may not have had much time to build any credit history at all. These are potential subprime auto loan clients.

Other potential candidates include those with poor to bad credit who, due to their less-than-impressive credit history, cannot get credit from traditional auto loan lenders. Whereas a poor or bad credit history is already bad news, those without any credit history present auto loan lenders with an even bigger challenge – they simply don’t know what to expect. It’s like taking a leap of absurdity into the unknown. These type of subprime borrowers have almost zero chance of securing a car loan with traditional (prime) auto lenders. So, where do they turn to?

Subprime auto loan lenders exist for people like this. Although they understand the risks involved, they more than compensate for these by charging exorbitant interest rates and processing fees. The high-interest rates and processing fees notwithstanding, people with little or no credit find subprime car financing a viable and welcome option.

Getting Financing From Subprime Auto Lenders

Advantages of Subprime Car Financing

Subprime car financing has some advantages, though not many, for both the lender and the borrower. For the lender, the high interests mean a wider profit margin. A subprime lender understands very well that they are taking a risk on a subprime borrower. To cushion themselves against this risk, the interest rates are adjusted upwards. They may also charge certain processing fees in view of the client’s risk profile.

As a subprime borrower, getting someone to offer you an auto financing facility is a breakthrough in itself. When no one else is willing to take a risk on you, it sure does feel good to know that someone is willing to take a chance on you.

Subprime auto lenders provide you with a chance to repair your credit. This is because, as you keep making your payments on time, they will report this good history to credit reporting bureaus. If you sustain this for some time, you will start seeing your credit score edge slowly out of bad credit. With time, you might even be in a position to refinance yourself out of your subprime loan and into a more appropriate facility.

Disadvantages of Subprime Car Financing

Although you will find many subprime lenders willing to approve an auto loan for you, the bad news is that you will have to pay punitive interest rates. It gets worse if you are sourcing for a subprime auto financing through a dealer. This is because dealers always add a markup. If you have to get a subprime loan, go straight to the lender.

You will also end up with a car you literally can’t afford. Most car dealers and subprime lenders know you are out of luck, and out of financing options. They will try to get you to take a loan with an eye on making the monthly payments easy on you. This, to most people, is a deal that shouldn’t be turned down. However, to get you those easy payments for between 72 to 84 months, it means you are going to pay even higher interest rates over a longer period. You might find yourself paying for a subprime auto loan long after you have purchased another car. To get the best out of a subprime loan, take the shortest duration possible to repay the loan and always make payments on time.

Getting Financing From Traditional Auto Lenders

Getting financing for a car from traditional auto lenders is definitely the better option. However, to secure a loan with a traditional auto lender, your credit history must be good. With a credit score of 650 points and above, your chances of getting a car loan on lower interest rates improve drastically.

Advantages of Approaching Traditional Auto Lenders

For the auto loan lender, dealing with clients with a reliable credit history means reduced risk. A client with a credit history of regular timely payments will most likely repay an auto loan on time. To an auto loan lender, a borrower’s credit history is the single most important determinant on whether to grant or deny an auto loan application.

For a potential auto loan borrower, approaching traditional auto lenders such as banks come with certain advantages. For instance, banks are some of the most established lenders. They are likely to have been around for some time. As a prospective auto loan client, you can be assured that your traditional lender will not be closing shop any time soon. However, when it comes to borrowing from a traditional lender, select one with a good reputation, integrity, and a huge cash flow.

A traditional lender such as a bank can also provide you with other valuable services such as a house loan. Some banks can even apply a home equity loan facility to a car loan. Making your bank a one-stop shop for all your financial needs helps you streamline your borrowing needs, such as taking an auto loan.

Another advantage of securing an auto loan from a traditional lender is that you can get pre-approved for a car loan. This means that you can approach a car dealer with confidence. When you are sure about an auto loan, you will not be at the mercy of a dealer who may be keen to not only sell you a car but also help you secure financing from lenders with punitive interest rates.

Disadvantages of Seeking Auto Finance from Traditional Lenders

To a lender, providing loans to a borrower comes with potential risk, no matter how good their credit score is. While a high credit score means higher credibility and less risk, there is always an element of risk. Most of those with bad credit had a good credit at one time or another. Every auto lender, therefore, is always conscious of the possibility that a good credit can suddenly turn bad.

Although borrowers with good to great credit scores will find it highly convenient to secure an auto loan from a traditional lender as opposed to a borrower with poor to bad credit, or no credit at all, securing an auto loan from a traditional lender is often a near-impossible task. You need good credit to secure financing from a traditional auto lender.

Which One is Right for You?

The merits and demerits of choosing one type of lender and not the other largely depend on a borrower’s specific situation. Besides one’s credit history, other factors may come to play when seeking auto financing. While subprime lenders charge exorbitant interest rates, they nonetheless open their doors to subprime borrowers, giving them a chance to qualify for an auto loan they would otherwise not have qualified for had they approached a traditional auto loan lender.

The ideal auto lender is the one with the most competitive interest rates. However, such lenders have stringent qualification requirements such as a good credit score that often locks out borrowers with bad to poor credit. To the latter group’s rescue comes subprime lenders who are willing to take a chance on them. However, this comes at the cost of interest rates that are way above the normal market rates offered by traditional lenders.

But perhaps one of the considerations people have to contend with is that bad credit is not a permanent verdict. It can turn towards good, and perhaps even great, as financial discipline and frugal spending kicks in. For such cases, a subprime lender offers a great chance to start the journey towards recovery without missing out on the car of their dreams.