taking notes on a book about loans

What are Subprime Loans?

Kimber Severance

Nothing’s worse than being denied a loan because of your credit score, but did you know there are different loan categories you could qualify for instead?

Subprime loans are one of several types of loan categories and one of the easiest loan categories to qualify for. Loan categories, like prime and subprime loans, are measured by credit scores to determine the level of risk the loan is for the lender. Some lenders only offer loan products with specific risk levels, like high-risk loans or low-risk loans. Since the lender is taking on all the risks, they will attach an interest rate to match that risk. That's why higher-risk loans will have higher interest rates and lower-risk loans will have lower interest rates. 

What is a Subprime Loan?

One loan characteristic that categorizes loans into prime or subprime loans is the rates they offer. As already mentioned, the higher the risk the lender is taking on the higher the interest rates and the lower the risk the lender is taking on the lower the interest rates. 

Subprime loans then describe the types of loans that are higher risk for a lender and come with higher interest rates. Prime loans then describe the types of loans that are lower risk for a lender and come with lower interest rates. 

A subprime loan is a loan category that is the riskiest for the lender but the easiest to qualify for as the borrower. Some examples of subprime loans include: 

When you get a loan you have to fill out and submit an application. This application will go over factors like your income and creditworthiness and then determine whether you can get approved for a loan. If you have a low credit score you might not qualify for a prime loan with lower prime rates. This means that if you have poor credit, your best loan option might be subprime loans with higher subprime rates. 

Prime Loans vs Subprime Loans 

There are 5 main loan categories based on credit score ranges. Not all the loan categories use credit scores to determine qualification, but it gives you a good idea of which type of lenders you will most likely qualify for based on your general credit score range. 

  • Credit Scores Below 580 = Deep Subprime Lenders
  • Credit Scores Between 580 and 619 = Subprime Lenders
  • Credit Scores Between 620 and 659 = Near-Prime Lenders
  • Credit Scores Between 660 and 719 = Prime Lenders
  • Credit Scores Above 720 = Super-Prime Lenders

The most common of these categories are prime and subprime loans. There are pros and cons to both loan types. 

Prime Loans Pros and Cons

  • Prime loans have more criteria and higher standards of qualification for loan application approval. They often require a credit score and a hard credit pull to determine whether an applicant is approved. This hard credit pull is then recorded on your credit report and impacts your overall credit score. 
  • Prime loans also have lower interest rates, larger loan amounts, and longer loan terms. So you can take out a few thousand dollars and repay it over a few years. 
  • With a prime loan, you can borrow more money and enjoy lower interest rates. But the longer loan term means it'll take longer to pay off the loan and over the long term you might end up spending a lot on interest. 

Subprime Loans Pros and Cons

  • Subprime loans are typically easier to qualify for, as they do not require a credit score or a hard credit pull on your credit report. Instead, subprime loan applications often use a soft credit pull to determine whether an applicant is approved. This soft credit pull is less likely to have any impact on your overall credit score.  
  • Subprime loans also have higher interest rates, smaller loan amounts, and shorter loan terms. So you can take out a few hundred dollars and repay it over a few weeks. 
  • With subprime loans, you can get smaller amounts of money and only be in debt and making loan payments for a few days or a few weeks instead of years. Because you're paying interest for less time, you might end up paying less interest overall, but there is a higher rate. 

How is Subprime Lending Different?

Because subprime and prime lenders offer such different loan products, subprime loans are often not found at traditional banks and lending organizations. Many lenders would rather focus on providing prime loans to prime customers who can qualify for those lower rates. 

That's where subprime lenders or small loan lenders come in to provide subprime loans to subprime customers. They focus on providing simplified financial services and practices to those who can't qualify and get into more traditional financial loans. 

There is also a difference between the credit checks that happen between prime and subprime loans. Prime loans often do what's considered a "hard credit pull" that usually affects your credit score while subprime loans often do what's considered a "soft credit pull" that usually doesn't affect your credit score. 

Main Credit Reporting Agencies 

These credit agencies gather personal information about credit users and use that information to create credit reports and credit scores for each person. Some examples of the main credit reporting agencies include: 

  • Equifax
  • Experian 
  • TransUnion. 

The information they gather is then used by other organizations like banks and lenders when customers want to take out a credit card or a loan. 

Subprime Credit Reporting Agencies

These subprime credit reporting agencies also collect information about you for companies that need to make decisions about you, like whether you should be approved for a subprime loan or not. Some examples of subprime credit reporting agencies include:

  • DataX
  • FactorTrust
  • Clarity Services

These agencies are also subject to the same Fair Credit Reporting Act and free credit report each year that the main agencies are subject to. 

Fair Credit Reporting Act

The Fair Credit Reporting Act was passed in 1970 and has been in effect ever since. It is a federal law designed to protect people and their information, particularly the personal information gathered by credit reporting agencies. 

The act helps make sure that your information is accurate, fair, and private. It also regulates how credit bureaus get your information and who has access to this information. You can find more information about the Fair Credit Reporting Act and the resources available to you with the Consumer Financial Protection Bureau (CFPB).

In Conclusion, 

There are a lot of nitty-gritty details when it comes to loans and credit. There is a lot to know, but it's worth it to take your time researching loans and credit. When you are well informed, you can become a more educated borrower and use your loans responsibly.