What Is a Subprime Borrower?
A subprime borrower is a person considered to be a relatively high credit risk for a lender. Subprime borrowers have lower credit scores and are likely to have multiple negative factors in their credit reports, such as delinquencies and account rejections. Subprime borrowers may also have a "thin" credit history, meaning they have little or no activity in their credit reports on which lenders can base their decisions.
- Subprime borrowers are individuals who are considered to represent a higher risk to lenders.
- They typically have credit scores below 670 and other negative information in their credit reports.
- Subprime borrowers may find it harder to obtain loans and will usually have to pay higher interest rates when they do.
- However, many lenders are offering new products to serve this market.
Understanding Who Becomes a Subprime Borrower
Lenders rely on credit bureaus to provide credit reports and credit scores on which to base their lending decisions. Credit scores are calculated using a variety of methodologies, and the higher the score, the better the person's credit is assumed to be. The most widely used credit score is the FICO score.
Experian, one of the three major national credit bureaus, breaks credit scores into five tiers. The top three tiers—known as "exceptional," "very good," and "good"—are reserved for individuals with credit scores of 670 and up. (The highest possible FICO score is 850.)
Subprime borrowers fall into the bottom two tiers, the "fair" and "very poor" categories. Fair credit involves scores ranging from 580 to 669; very poor credit is anything lower than 580. (The lowest possible score is 300.)
Their low credit scores make it hard for subprime borrowers to obtain credit through traditional lenders. When they are able to obtain loans, subprime borrowers will generally receive less favorable terms, compared with borrowers who have good credit.
Subprime lenders, companies that specialize in this market, are willing to take on the greater risk that subprime borrowers pose in return for higher rates of interest. While subprime lending can be a profitable business, it was one of the major factors that led to the subprime mortgage crisis in the U.S. in 2008. Many lenders, specifically in the mortgage market, relaxed their requirements in order to attract more borrowers. These mortgages had higher rates of default and subsequently led to new regulations, primarily the Dodd-Frank Act, which tightened the standards for lending across the credit markets.
Types of Subprime Products
In today's emerging fintech market, a number of new companies, including various online lenders, now focus on subprime and thin-file borrowers. Credit agencies have also developed new credit scoring methodologies for such borrowers. This has helped to increase the available offerings for subprime borrowers.
Secured credit cards can help subprime borrowers improve their credit scores and eventually qualify for a regular credit card.
One widely available product that provides an alternative for subprime borrowers is the secured credit card. The borrower puts money into a special bank account and is then allowed to spend up to a certain percentage of that amount, using the secured card. After a period of time, the borrower may be eligible to upgrade to a credit card with a higher credit limit.
Some companies also offer conventional, unsecured credit cards tailored to subprime borrowers. They include Credit One Bank, First Premier Bank, and First Savings Bank. The interest rates on these credit cards can top 30%, and they often carry annual fees of $100 or so and monthly fees ranging from $5 to $10 a month. These cards usually also have a lower credit limit than other cards, which is another way lenders mitigate some of the subprime risks.
In addition to credit cards, many subprime lenders also offer non-revolving loans, such as car loans, with interest rates in the range of 36%.
Payday lenders are another, more controversial, subprime credit alternative. These lenders provide short-term loans at annual percentage rates (APRs) that can exceed 400% in some states.
In mortgage lending, subprime borrowers can present less risk than in other types of lending because the mortgage is secured by the home itself. Still, subprime borrowers may have a more difficult time obtaining a mortgage and can expect to pay a higher interest rate than the average borrower if they do.