If you’re trying to build your credit score for the first time or are rebuilding your credit after past mistakes, you may find it difficult to figure out how to get a loan with favorable terms through a traditional bank.
The fact of the matter is that not everyone qualifies for high-quality prime loans. And if you don’t, you’re not alone. According to Experian data, 34.8% of consumers with a credit score fell into the subprime range in the fourth quarter of 2018.
For those in this credit score category, subprime lenders offer an option. When deciding whether or not a subprime lender is right for you, make sure you do your research, understand what you’re agreeing to, and take into account all other options.
What are subprime lenders?
A subprime lender is one who specializes in lending to prospective borrowers with relatively new credit history or to those with poor credit.
Because characteristics such as low income, high debt, and poor credit might suggest that a borrower is more likely to default on their loan, subprime lenders often take on more risk than traditional lenders. Therefore, subprime loans often carry higher interest rates and monthly payments, as well as fees that may not be charged to borrowers with good credit.
Loans offered by subprime lenders affect your credit just like any other loan would. Making your payments on time is just as important for improving your credit, while missed payments and defaulting on your loan are just as detrimental, putting you in a position where it’s tougher to borrow in the future.
While prime loans offered by traditional lenders tend to come with the best interest rates, terms, and lowest fees, the qualification criteria is stricter. The standards vary depending on the lender and the loan product, but in most situations, borrowers have to meet certain income and debt levels and have a credit score higher than 660 to be considered for prime lending. Meeting these standards makes borrowers more attractive loan candidates, so they can often qualify for loans with lower interest rates, higher credit amounts, and lower down payments.
Are all subprime lenders bad?
No. While there are surely some lenders out there who try to take advantage of borrowers, not all subprime lenders are bad.
Lenders who use unfair or deceptive tactics to steer a borrower toward a loan with abusive terms are known as predatory lenders. The terms of these loans usually involve high interest rates, additional fees, or other terms that benefit the lender at the expense of the borrower.
While some predatory lenders may target subprime borrowers, anyone can fall victim to these predatory practices, making it ever more important to conduct thorough research when comparing lenders.
Here are some red flags to watch for when comparing subprime lenders:
1. The use of aggressive sales tactics
Be wary of subprime lenders who aggressively try to push products onto you. For example, if you inquire about a certain type of loan and the lender pressures you into a more expensive offering, be cautious. Similarly, if a lender pushes you to act quickly or sign papers immediately, they may not have your best interests in mind.
2. Payments that are too low
While offering a low payment isn’t predatory in and of itself, watch out for advertisements promising lower monthly payments as a way out of debt without telling borrowers that they will likely be paying more in interest and for a longer time.
Depending on the amount, taking on a loan with low payments and high interest can leave you paying an exorbitant amount of money in the end.
3. Lack of transparency about the cost of the loan
All of the costs associated with the loan should be upfront, including prepayment penalties, late fees, and the loan’s interest rate. If a company is having a hard time telling you how much the loan will cost you, steer clear.
4. Bad reviews
Since pretty much everything is reviewed online nowadays, do a search to see what others have said about the lender. If the general consensus is that they shouldn’t be trusted, it might be a sign to keep shopping.
6 things to try before using a subprime lender
If you can’t qualify for a traditional loan and don’t feel comfortable with a subprime lender, there are still options you can consider.
1. Check your credit report and dispute any errors
While you should always check your credit report at least once a year, you might want to give it another look before deciding to work with a subprime lender, since the information on your report affects the terms of the loan.
If you find there’s an error on your credit report, dispute it. Something like a collection item that was never updated after a settlement can negatively impact your score. If the dispute is resolved in your favor, you could see your credit score increase.
2. Work on improving your credit score
If you have the time and resources, consider working on improving your credit score before reaching out to a subprime lender. Keep making your payments on time and work on paying off bad debt, such as credit card balances.
If you can make these improvements, you’re more likely to be approved for better rates and terms that won’t cost as much in the end.
3. Consider non-traditional lenders
An alternative to traditional banks and subprime lenders that have gained popularity over the years are peer-to-peer (P2P) lending services. P2P lenders act as facilitators, connecting potential borrowers with lenders — oftentimes individuals. With just a few clicks, borrowers may find potential loan offers after meeting a few basic eligibility criteria.
While P2P lenders such as LendingClub often serve borrowers who can’t qualify for prime loans, they still have requirements that need to be met, such as a regular income and certain credit history patterns.
Credit unions can be a helpful resource as well, as they often provide access to financial services for people of all income levels. Credit unions operate with a focus on the well-being of their members, so their profits are often returned back to members through reduced fees, higher savings rates, and lower loan rates.
If your situation calls for a small, short-term loan, federal credit unions can offer an alternative to a high-cost payday loan. Payday Alternative Loans, or PALs, are small dollar loans ranging from $200 to $1,000 that must be repaid within one to six months. The interest rate of a PAL can’t exceed 28%, and while credit unions can charge an application fee, it can’t exceed $20.
4. Use a cosigner to apply for a prime loan
A cosigner could help your loan application if you don’t meet certain requirements, such as a minimum income level, no established credit, bad credit, or high debt-to-income ratio.
Having a cosigner with a good credit profile may help you gain access to the credit you need, not to mention help you establish or rebuild your credit. However, your cosigner will be legally responsible for your debt — if you can’t repay it, they will be on the hook.
5. Inquire about an advance from your employer
If you’re short on cash, you might consider turning to your employer for a pay advance. Check with your human resources department to see if they have such a policy in place and what the terms are.
Keep in mind that if you borrow, say, $300 from next week’s paycheck, that next week’s paycheck will be $300 lower than normal. If that will leave you short again, a payroll advance may not be the best option, as it might keep you in a loop of financial struggle.
6. Borrow from family or friends
Borrowing from family or friends might be the most affordable method, since you aren’t paying the fees and high interest rates you would be paying with a subprime lender.
Keep in mind that this also sets up the possibility of tarnishing personal relationships if you don’t pay them back. This could lead to added stress in a time that’s probably already stressful.
Subprime lenders aren’t all bad, but they’re not the only option
Subprime lenders offer a service to borrowers who fall short of qualifying for the best loans, but it comes at a price. For the risk they assume, you may face higher interest rates, fees, and terms that may not be charged to those who qualify for prime loans.
If you decide to borrow from a subprime lender, it’s crucial that you understand exactly what you’re signing up for. While the interest rates and fees may be higher, subprime lenders should provide total transparency on the details of the loan. If they don’t and you find yourself being led down a road that isn’t what you expected, step back and consider the other options available to you.