Subprime. It’s a word that has been heard a lot over the past few years, but not many people actually know what it means. Subprime is a term used to define a specific group who are considered the riskiest borrowers in the financial lending world. Although there is no set credit score attached to subprime lending, the standard in the United States tends to be for a borrower who has a FICO score below approximately 640. Subprime lending covers a variety of credit types, including auto loans, mortgages, and credit cards.

As previously stated, subprime is usually reserved for borrowers with a credit score below 640. Usually subprime consumers have either marred or limited credit histories that may comprise of excessive debt, a history of missed payments or failure to pay debts, and recorded bankruptcies. Subprime borrowers are typically considered high-risk because of their less-than-ideal credit record, and lenders use a variety of methods to offset these risks; typically in the form of higher interest rates or fees. These higher fees compensate the lender for the increased costs related to servicing and collecting on these types of accounts, as well as for the higher rate of default on these types of loans.

However, subprime should not be considered a permanent negative status for those consumers who are classified as such. Many consumers in the subprime category did not get there completely of their own negligence. Burdens of life like job loss, marital problems, or unforeseen medical issues, usually cause major financial setbacks. And because of these unexpected difficulties, late payments, repossessions, charge-offs, and even bankruptcies may result.

Nonetheless, subprime borrowing can extend credit to people who may otherwise not have access to the credit market. Lenders allow individuals to receive subprime loans while paying higher interest rates and fees; but this allows for loans that would otherwise not occur for people who would typically be denied lines of credit altogether. Borrowers can use this credit to finance the purchasing of a car, or to buy a house, or for remodeling a home. And just because someone may have a bad credit rating, it does not mean they would not have sufficient income to support payments on a subprime loan.

Proponents of subprime lending maintain that it can provide a method for individuals to repair or improve their credit rating. If a borrower can uphold a good payment record, most lenders will allow for them to refinance into more mainstream or prime rates after a few years. Subprime loans may carry higher interest rates, but provided the consumer enters into their loan with the knowledge that they are a higher risk to lenders, and that they must make every effort to issue timely payments, these loans do in fact serve many borrowers who would otherwise be underserved, and provide them a way to move further out of subprime rating in the future. When an individual enters into a subprime loan, they should be realistic in their expectations and be honest about what they can afford, and only take on a payment that is well within their budget.

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Category: Finances
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