FICO Scores & Credit Reports

Prime vs. Subprime Loans: How Are They Different?

FICO^® Scores are one of the key metrics that many lenders use to evaluate a borrower's creditworthiness. For this reason, your credit score can impact not only your loan approval odds but also the rates and terms you're offered.

The various FICO Score ranges that borrowers may belong to are often described as "prime" or "subprime." Borrowers with the strongest FICO Scores may be offered prime loans, while borrowers with bad or damaged credit may only qualify for subprime loan options.

But what exactly do these terms mean? Let's take a closer look at prime vs. subprime loans to help you understand their differences and what you should know before taking out a subprime loan.

What Does It Mean to Be a Prime or Subprime Borrower?

Prime borrowers are considered the least likely to default on a loan. Subprime borrowers, meanwhile, are viewed as higher default risks due to having limited or damaged credit histories.

Lenders use several FICO^® Score ranges to categorize loan applicants. Consumers with scores in the top range are the most prime (or "super-prime"), and borrowers in the bottom range are considered "deep subprime."

Prime vs. subprime credit score ranges used can vary by lender. For example, some lenders may use the following FICO Score ranges:

Super-prime (FICO Scores of 720 or above)
Prime (FICO Scores of 660-719)
Near-prime (FICO Scores of 620-659)
Subprime (FICO Scores of 580-619)
Deep subprime (FICO Scores below 580)

To learn more about FICO Score ranges and why they matter, check out this quick guide.

Prime vs. Subprime Loans: How Are They Different?

The biggest difference between prime and subprime loans will usually be in the interest rates they charge. It's generally viewed as riskier to lend to borrowers with impaired or limited credit histories, so lenders charge higher rates to compensate for that risk.

A recent study by Columbia Business Law Review found that subprime auto loans can have interest rates that exceed 29%. And the CFPB found that payday personal loans, which subprime borrowers may turn to as a last financing resort, can charge fees that translate to annual percentage rates (APRs) of nearly 400%.
There may be other differences, as well. Prime loans, for instance, maybe offered in larger loan amounts. Subprime loans, on the other hand, may require larger down payments or charge higher origination fees.

Best and Worst Loan Options for Subprime Borrowers

It's possible to get a loan even if you have a subprime FICO^® Score. But not all subprime loans are created equal. Here are some of your best and worst options for a variety of loan types.

Personal Loans

If you need fast cash, it can be tempting to visit a payday loan company or other lenders that offer short-term personal loans without credit checks. But some of these loans may not be in your best interests. And many of these loans may come with fees and/or interest rates that are so high that borrowers can easily get trapped in a debt cycle.

You may be able to avoid those types of loans by taking out a Payday Alternative Loan (PAL) from a local credit union. Generally, these loans don't come with charges more than $20 in fees and have maximum interest rates of 28%. PALs come in loan amounts of $200 to $1,000 and terms of one to six months.

Auto Loans

Some car dealerships offer in-house financing that may be geared towards borrowers with subprime FICO^® scores. In fact, some of these "Buy Here, Pay Here" dealerships proudly advertise their "No Credit, No Problem" policy. But these loans can come with higher interest rates. And, in some of the worst cases, you may pay more than the vehicle is actually worth by choosing those "Buy Here, Pay Here" dealership financing.

But you may have better options. Before you start the car shopping process, see if you can get pre-approved for a loan with a lender, bank, or credit union. In some cases, you may be able to secure a much better deal with a third-party lender than the dealership's in-house financing option.

Credit unions can be an especially effective way to discover low car loan rates. According to the National Credit Union Administration (NCUA), the average 48-month loan for a used car in Q3 2020 was 2.08 percentage points lower at credit unions than banks. And credit unions were better on 48-month new car loan rates too by an average of 1.80 percentage points.

Mortgages

In the early 2000s, subprime mortgages were fairly easy to come by. Many mortgage lenders not only accepted borrowers with low FICO^® Scores but also failed to verify that borrowers had enough income to make their loan payments.

The end result of these practices was the mortgage crisis and recession of 2008. Mortgage companies are now more regulated and must follow higher underwriting standards. However, subprime mortgages are still available. Often, these loans come with adjustable rates, which means they can rise dramatically over time.

However, subprime borrowers who are looking to buy a home that will be their primary residence may be able to take out a fixed-rate FHA home loan. Borrowers may qualify for an FHA loan with FICO Scores as low as 580 and down payments as low as 3.5%. And if you're able to put 10% down, the FHA FICO Score minimum can be as low as 500.

VA and USDA loans are two more government-insured home loans that have lenient credit requirements. But it's important to note that while subprime borrowers may get approved for a mortgage through the help of these programs, they'll still be unlikely to qualify for the best available rates. See how your FICO Score could affect your mortgage rates.

Are Subprime Loans Worth It?

There are times when it's simply not practical to wait till you can qualify for prime loans. For example, you may need to buy a car immediately so that you can continue to make it to work each day.

And, in emergency situations like these, taking out a subprime loan could make sense. But even when it's necessary to take out a subprime loan, you'll still want to shop around with multiple lenders to compare rates and terms.

In other situations, you may be better off waiting to take out a loan until your FICO^® Score has improved. This could especially be true for large loans like mortgages where even a slight interest rate difference can significantly impact how much you pay over the life of the loan.

Remember, the information in your credit reports is constantly updating, and your FICO Scores are too. By following solid credit habits over time, a subprime borrower can become a prime borrower. Learn more about the factors that affect your FICO Scores.

Clint Proctor

Clint Proctor is a freelance writer and founder of WalletWiseGuy.com, where he writes about how students and millennials can win with money. His work has been featured in several major publications including Business Insider, U.S News and World Report, Yahoo Finance, and Forbes.