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The Ins and Outs of Subprime Auto Loans

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When it comes time to buy a car, if you have a low credit score or limited credit history, you may be worried about getting turned down for an auto loan. But borrowers who have poor or bad credit scores can still qualify for subprime auto loans. These are also called second chance auto loans, and some auto lenders and dealerships specialize in them. Though these loans can help finance the purchase of a new car or used car, they also have some drawbacks. This article will explore the ins and outs of subprime auto loans, so you can decide if they’re right for you.

Written by Attorney Tori Bramble
Updated November 26, 2021

When it comes time to buy a car, if you have a low credit score or limited credit history, you may be worried about getting turned down for an auto loan. But borrowers who have poor or bad credit scores can still qualify for subprime auto loans. These are also called second chance auto loans, and some auto lenders and dealerships specialize in them. Though these loans can help finance the purchase of a new car or used car, they also have some drawbacks. This article will explore the ins and outs of subprime auto loans, so you can decide if they’re right for you.

What Are Subprime Auto Loans?

Subprime loans are loans for borrowers with poor or fair credit scores. While there are no hard-and-fast rules about what credit scores are considered subprime, there are some general guidelines. FICO credit scores range between 300 and 850. Borrowers with FICO scores below 650 are less likely to qualify for traditional financing and more likely to need subprime auto loan financing. Subprime loans tend to have higher interest rates than prime loans, which people with better credit can access. 

Because subprime auto loans are so risky to lenders, borrowers may be asked to provide additional financial information for loan approval. You might be asked to provide your bank statements, pay stubs, W-2s, and 1099 forms to get approved. Make sure that you have a stable job that won't likely be affected by the pandemic.

Since fees and loan terms vary from lender to lender, it's important to shop around for the best subprime car loan, or if you're in one to contact your loan servicer to discuss your loan options. If possible, try to improve your credit score to improve your chances of qualifying for a traditional car loan. This will help you access a lower interest rate and better terms, which results in a lower monthly car payment. 

How Credit Scores Affect Auto Loans

Your credit score is calculated from the information in your credit report and history. It gives lenders a sense of your borrowing history and whether you’ve reliably paid off past loans and debt. They use this information to decide how risky it will be to lend money to you and how likely you are to pay it back or default. If you have a long history of making payments on time, you’ll have a higher credit score than someone who’s missed payments or made late payments.

If you have a lot of negative entries like late payments or a repossession on your credit history or you haven’t had loans or credit cards and you don’t have much experience with credit, your credit score may be fair or poor. If your credit score is between 450 and 650, you may be considered a subprime borrower and not qualify for traditional auto financing. 

Those with good credit scores are more likely to qualify for loans and get them on better terms with lower interest rates, including 0% financing. If you have a fair or bad credit score, you may struggle to get approved for financing. If approved, you may have to pay a higher interest rate, put down a larger down payment, and/or have a high monthly payment. Essentially, borrowers with low credit scores pose a significant risk to lenders and as a result, lenders charge them more for financing.

How To Improve Your Score

There are several ways to improve your credit score if you have no credit or bad credit. First, make your payments on time. One way to do this is to sign up for automatic withdrawals from your checking account so you can make sure to pay your minimum monthly payments on time each month. 

Next, try not to max out your credit cards. Spending 30% or less of your credit limit means your credit utilization rate is lower, which can boost your score. Also, don’t close credit card accounts, especially older ones, even if you're not using them. Lenders like to see that you have a long credit history. And even unused credit accounts are beneficial because they can help decrease your credit utilization rate as well. Finally, remember to check your credit reports regularly and dispute any inaccuracies you find on them. 

Pros and Cons of Subprime Auto Loans

There are pros and cons to subprime loans. The first pro is that it’s easier to get approved for a subprime loan than a prime, or traditional, loan. Many subprime lenders don’t run a credit report or don’t care about your credit score. Even if you've defaulted on a car loan in the past, most subprime lenders will approve you if you have a job. A subprime loan may be your only option to get a reliable new vehicle or used car.

Subprime loans are expensive, and this is their biggest drawback. Having a lower credit score often means you’ll have to pay a higher interest rate, in addition to other expenses like a loan origination fee and prepayment penalties. This can all add up. This puts subprime loan borrowers on the hook for higher car payments because they're a higher risk to the lenders compared to prime borrowers. 

Interest Rates and Risk

It's helpful to know that interest rates reflect a lender’s risk. The more risky the borrower is, the higher the interest rate the lender will charge. The high interest rate pays the bank or lending company in case the borrower happens to default. The processing fees and other expenses that go along with getting a loan are also higher in the subprime market. But this can create a high monthly payment, and if you can’t afford to pay it or fall behind on payment, you risk having your car repossessed. This can lead to more fees and even a lawsuit against you. 

Finally, subprime lenders may be less strict about your credit score than other lenders, but they’re stricter when looking at your income. You’ll have to have enough income to cover monthly payments. Banks will verify your financial documents to see if you can make payments on schedule.

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Addressing Risks Associated With Subprime Auto Loans

It’s important to do your homework and evaluate your options before taking out a subprime loan. Taking out these loans can be risky. But there are ways to address these risks and put yourself in a position to get out of subprime territory. For instance, start by making sure you’re going into the lending process with the highest possible credit score. You may be able to give your score a boost by reviewing your credit report and disputing errors or incorrect information that are dragging your score down. Incorrect information is more common than most people realize. 

If your score is as high as it’s going to be when it comes time to buy your car, make sure you know what monthly payment you can afford. Knowing your monthly income and expenses and using this information to make a simple budget is a good way to make sure you’ll have enough money to make your car payments. Ask the lender about the payment structure. If you need to make a weekly payment unsteady of a monthly one, this might be unmanageable, for example. 

Remember to account for the total cost of car ownership

Also, don’t forget to account for the added expenses of car ownership. In addition to your car loan payment, you’ll need to have enough to cover auto insurance, gas, maintenance, and repairs. If all these expenses add up to more than you can afford, you may need to wait to buy a car or look for a lower-priced option. Remember that if you miss even a single payment on the loan, the lender can repossess your car. This will cause further damage to your credit score, so avoid it at all costs. 

Let's Summarize... 

If you’re in the market for a car but have bad credit, you may have to take out a subprime auto loan to purchase a new or used vehicle. Subprime auto loans give people a second chance at getting a car if they’ve been rejected for a traditional auto loan. 

It's important to know all the risks and benefits before you take a subprime loan. Also, be sure you can afford the payment as well as other car-related expenses including taxes, fees, insurance payments, maintenance, and repairs before signing on the dotted line for these loans. If you're confident you can make on-time payments and maintain a car then you can get approved and on the road with peace of mind. 

Written By:

Attorney Tori Bramble


Tori Bramble is a bankruptcy attorney with over 20 years of experience. She is licensed to practice in Maryland and Virginia and has helped over 1,500 clients discharge thousands of dollars and find debt relief by filing Chapter 7 or Chapter 13 bankruptcy. A New York native, Tori... read more about Attorney Tori Bramble

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