When you apply for an auto loan, there are multiple factors that can affect your exact terms, conditions, and payment plan. Many dealers and lenders offer different types of loans depending on your needs and your credit score or income. Subprime auto loans provide an option for consumers with less-than-ideal credit scores or limited credit histories. Learning about subprime loans can help you evaluate whether it’s a viable option for you when purchasing a car.
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What Are Subprime Auto Loans?
Subprime auto loans are credit loans given to customers who have a credit score that lenders consider subprime. The exact credit score range for these loans can vary depending on the lender or source. If you’re a first-time borrower or you have no credit history, you may be offered a subprime loan to protect the lender from any risks that you may present as a borrower. The Consumer Financial Protection Bureau (FCPB) ranks credit scores in the following ranges and categories:
- Deep subprime: Below 580
- Subprime: 580 to 619
- Near prime: 620 to 659
- Prime: 660 to 719
- Super prime: 720 or higher
You can use our buyer’s guide to help you determine how your credit score can affect your auto loans and view your options when buying a new or used car.
How Does a Subprime Auto Loan Work?
A subprime auto loan works as a regular loan, meaning a lender agrees to provide you with the finances to purchase a car and you agree to a monthly payment plan that includes interest and fees. Because a subprime loan is used by individuals with a lower credit score or no credit history, the interest rates and fees typically appear higher than normal to protect the lender from risks and losses.
Depending on the lender, they may also require you to provide additional information, such as a W-2 or bank statement, during the application process. These documents allow them to assess your ability to make payments and uphold your agreement.
How to Get a Subprime Auto Loan
Getting a subprime loan can benefit you when you need to buy a car but have limited resources and low credit. You can follow these steps to secure a loan that works for you:
1. Check Your Credit Scores
Knowing your credit scores can help you identify your loan options and evaluate what agreements you qualify for. You can also use this information to determine your budget and ability to make monthly payments. Auto lenders typically look at your credit scores and payment history to categorize the level of risk you present as a borrower and calculate your interest rate accordingly. Check your credit report prior to signing your loan agreement to ensure you receive a fair offer for interest rates and fees. The good news is, you can do this for free. Go to AnnualCreditReport.com for a free annual credit report from each of the three credit reporting agencies: Equifax, Experian, and TransUnion. You may also get a free credit score each month through your credit card provider. Citibank, CapitalOne, Amex and others offer this, so make sure to check.
2. Apply for Subprime Loans
Once you know how your credit score appears, you can apply for loans with qualifications that match your status. Consider applying to multiple lenders so that you can compare and evaluate different payment amounts, loan terms, and interest rates to get the best deal. Don’t drag it out though, as an auto loan will only count as one inquiry on your credit report, even if you send out multiple applications, only if you apply within a 14-day period. Many dealers and lenders allow you to apply for financing online to see if you qualify and to give you a quote based on your information. For these loans, the application may also ask you to provide pay stubs, W-2s, or bank statements in addition to your credit report to prove your ability to make payments.
3. Negotiate the Terms
Once you receive a subprime auto loan offer from a lender, you can view and negotiate the exact terms of the contract before signing it. Talk with a representative about any changes you want to make to determine the duration of your payments, interest rates, and parameters. Ensure that your negotiations offer fair and realistic conditions, and prepare to compromise if the lender can’t accommodate certain aspects. Negotiate until you receive an offer that works for both you and the lender.
4. Sign Your Agreement
When you feel satisfied with the terms of your loan agreement, sign the paperwork to complete your deal. By signing, you agree to make your payments on time and uphold the terms of your contract. You can meet with a dealer or a representative to complete the details and close the deal before you drive your vehicle off the lot.
Risks of a Subprime Auto Loan
If a dealer or credit union offers you a subprime loan for your purchase, you can evaluate the potential risks and dangers that come with the terms of the offer. These loans typically have more strict parameters and conditions to protect the lender from higher potential losses. The most common risks include:
High Interest Rates
A subprime loan comes with higher-than-average interest rates. The higher rates work to protect the lender from the risks associated with late or missed payments. The exact terms and interest payments can vary depending on your lender, so you may want to shop around and receive a few quotes before signing any paperwork to ensure you get a good deal.
For auto loans, the interest rate appears as an annual percentage rate (APR). The average APR for a new car varies depending on your credit score but appears at a higher percentage for those with a subprime score. Here’s the most recent data for average APRs according to credit score for new vehicle purchases:
- Deep subprime: 12.53%
- Subprime: 9.41%
- Near prime: 6.07%
- Prime: 3.51%
- Super prime: 2.47%
Extra Fees
Because a subprime loan comes with greater risk for the lender, they often apply extra fees and costs at the beginning to minimize their losses and ensure your ability to pay. These fees include processing charges, service contract terms, and prepayment fees. You also assume responsibility for late payment fees and default payment penalties if you miss your payment or default on your loan.
Defaults and Repossession
Sometimes, the high fees and rates associated with a subprime loan make for an unrealistic payment plan for you as a consumer. If the monthly payment plan doesn’t fit your budget, you may have a higher risk of missing a payment and defaulting on your portion of the loan agreement. When you default on your payments, the lender can legally repossess your vehicle as compensation for your missed payments.
Factors of a Subprime Auto Loan
While your auto loan largely depends on your credit score, there are other factors you can consider that affect your monthly payments and overall costs. Before you sign a loan agreement, ensure you evaluate the overall terms, including elements such as:
Payment Schedules
The payment schedule and overall length of your loan can influence your total cost and your monthly minimum payments. If you agree to a 36-month loan instead of a 24-month plan, your monthly cost will be lower, but your total interest is higher. In contrast, if you agree to the 24-month lease, you pay more each month but save on 12 months of interest overall.
Typically, a financial representative at a dealership can help explain your options and determine a payment schedule that fits your budget and needs. The average loan agreement spans 24 to 60 months, but many dealers and lenders now offer 72- or 84-month options. Evaluate how long you plan to pay off your vehicle to find a payment schedule that works for you. Also keep in mind that the longer the loan, the more total interest you pay and the higher the risk that you may owe more on the loan than the car is worth by the end of the loan period.
Down Payments
When you want to purchase a vehicle, it can help to have enough money saved up to place a down payment. This amount subtracts from the principal of the loan and can reduce your monthly payments and overall cost of interest. The larger your down payment is, the cheaper your loan and interest will be, and you may be able to shorten the duration of your loan agreement. Many dealerships allow you to finance a car without a down payment, but putting money down at the beginning can save you money in the long run.
Penalties
Like any contract or agreement, a subprime auto loan includes penalties and fees for things like late payments and defaults. Depending on your lender and the terms of your loan, late payments can cause a higher interest rate or late fees. Making a late payment may also decrease your credit score and make it harder for you to improve your rating. Too many late or defaulted payments can result in the bank or dealer repossessing your vehicle. Make sure you read over the terms and penalties of your agreement before you agree to the loan.
Alternatives to a Subprime Auto Loan
Consumers with a subprime credit score may not want to pay the additional costs associated with the subprime loan. You can take additional steps or pursue alternative methods to avoid this type of agreement. Here are some other options to consider when looking for a car when you have a low credit score:
Leasing a Vehicle
Leasing a car from a dealership instead of purchasing it can offer many advantages, such as lower monthly payments and fewer service costs. Getting a lease with a subprime credit score can be difficult, but it’s not impossible. The exact credit requirements for a leasing agreement are different for each dealership and may vary depending on the make and model of your desired vehicle. If you want to avoid a subprime car loan, you can ask about a lease at various dealerships and find one that you qualify for.
Improving Your Credit Score
Luckily, there are steps you can take to improve your credit score over time. While this means you may have to delay your vehicle purchase, it can help you save money in the long run. If you have the ability, work to increase your credit score by opening a credit card and making regular on-time payments. You can also work to reduce any debt you currently have to improve your debt-to-income ratio and boost your credit score.
Research lenders to identify the minimum credit score necessary to qualify for a loan with lower interest rates or fewer fees. Once you achieve a higher credit score, you can apply for and earn a regular auto loan with less interest.
Adding a Co-Signer
Those with subprime or limited credit history can improve their chances of getting a better loan by having a co-signer added to the agreement. A co-signer is a second person who agrees to take responsibility for the loan in the case of default payments. If you can find a co-signer who has a prime or super prime credit score, many lenders will allow you to add them to your loan contract to receive a lower interest rate or fewer fees. The exact requirements and benefits of having a co-signer can vary depending on your lender.
If you can pay for the additional rates and fees, a subprime car loan can provide you with the ability to buy a car despite having poor credit or limited credit history. You can use this time and payment contract to build your credit and improve your score for the next purchase. When you’re offered a subprime auto loan, consider all the factors and ensure you can realistically achieve your payments and uphold your portion of the agreement.
Finance Editor
Jim Slavik is a financial services expert with 30 years of strategic and operational experience including leading underwriting, loan administration, customer service and collections. He has held C-suite credit operations roles for Fortune 100 and private equity companies for credit cards, personal loans, lease-to-own, auto loans, mortgages, and insurance for prime and sub-prime borrowers.
Currently Mr. Slavik is an independent financial services consultant for private equity firms and a contributor for expert networks such as GLG, Guidepoint, and Level company amongst others.
