Subprime Auto Loans vs Standard Auto Loans

Subprime auto loans can be a great option for an individual who may be struggling to raise their credit score. However, a standard loan is much more desirable as it will offer lower interest rates. If your credit is less than perfect and are considering financing for a car, be sure to read the information below as to what a subprime loan is, what a standard loan is, and how the loan terms will affect your monthly payment.

Definition of Subprime Auto Loans

A subprime auto loan is used for a person that has a less than stellar credit score or a limited credit history. This type of loan will come with a higher interest rate and potentially have pre-payment penalties if the borrower pays it off early. Usually, the borrower’s credit rating has to fall below a score of 620 to be considered subprime. In general, it is best to shop around for rates if forced to go with a subprime loan. Not all lenders use the same criteria and some charge larger fees than others. The interest rates can be quite steep compared to a standard car loan because the lender wants to ensure it can recoup costs should the borrower default on the payments.

Definition of Standard Auto Loans

If possible, it is much more desirable to qualify for a standard auto loan. This type of loan keeps in line with the current interest rates, even if there is some variable between lenders. Standard auto loans do look at credit scores in order to determine interest rates, allowing those rates to rise as credit scores lower. However, these rates are still much less than a subprime rate.  A standard car loan benefits from a down payment, though some lenders do not require them. Like a subprime, it is still important to shop around for the best loan rate. Car dealers will offer financing, often at a point or two higher than a traditional lender. However, some dealers will negotiate the financing if they have more than one lending option available. 

How the Loan Terms Affect You

Purchasing the auto is often all about what the borrower can budget for payment. There are many lenders that allow borrowers to stretch their payments over six or seven years, while the standard loan only allows three to five. While this lowers the payment, it can also carry a higher interest rate. Also, stretching that payment out longer will also result in you paying more interest overall. It may end up that you are paying more towards the interest than the principal, which results in you owing more on the car than it is actually worth. This term is called “upside down” when the loan amount is more than the value.  Cars depreciate quickly, and a long term loan can actually hurt the borrower if they attempt to sell the vehicle or trade it if they end up owing more.

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