Why subprime loans exist
Auto lenders establish loan rates based on borrower credit scores. Borrowers with poor credit tend to have an unfavorable payment history and high levels of revolving debt, so they’re considered a bigger risk than borrowers with a strong payment history and minimal debt. To mitigate this risk, lenders impose higher borrowing rates in the course of writing loans.
But some lenders take advantage of subprime borrowers by charging rates that are truly exorbitant. And the reason borrowers accept those sky-high rates is that they have no choice.
In many cases, like Patterson, borrowers can’t function without a car, don’t have the savings to buy one in cash, and can’t qualify for a better rate than the subprime offers they’re presented with. And so they sign on the dotted line and bear the consequences.
As of the second quarter of 2024, almost 17% of auto loans were subprime, says Experian. The average new subprime loan payment during that time was $749, and the average new subprime loan amount financed was $38,045.
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Explore better ratesHow to spot a subprime loan
The problem with subprime loans is that their exorbitant interest rates can lead to expensive monthly payments you might struggle to keep up with. And, like Patterson, you might end up paying more in interest than the cost of your actual vehicle.
Generally speaking, if the interest rate you’re presented with seems unusually high, it’s a sign that you’re being offered a subprime loan. Experian reports that as of the second quarter of 2024, the average subprime auto loan rate for new vehicles was 13.18%, compared to the average 6.87% prime loan rate for borrowers with good credit. But if you’re not familiar with typical interest rates, you may not realize you’re being overcharged.
A better bet may be to look at your credit score. If you have a FICO Score below 670, you’re at risk of getting stuck with a subprime loan, says Experian.
Alternatives to subprime auto loans
A subprime auto loan could cost you more than expected in interest and put you at risk of missing payments and wrecking your credit. So it’s a good idea to try to avoid a subprime loan if you can.
One option is to hold off on buying a car and work to improve your credit score, which you can do by paying debts on time and reducing credit card balances. But if you need a car immediately like Patterson did, that may not be an option.
In that case, one tactic that might work is getting someone with better credit to cosign an auto loan for you. That could help you qualify for a better rate.
Otherwise, you can try negotiating your subprime rate down with your lender. If they want your business, there may be some wiggle room.
And remember, you’re not necessarily stuck with a subprime loan until your car is paid off. If your credit score improves, you can try to refinance your auto loan. If you’re able to qualify for a lower interest rate, it should result in lower, more manageable monthly payments.
And that, in turn, could help you stay current on your car payments, which should only benefit your credit score even more.
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