A sub-prime loan is an expensive loan offered to people with poor credit scores. While the sub-prime loan has been lauded for assisting people with poor credit scores so they can buy houses and cars, the sub-prime loan has also been the topic of much concern in the past few years, since so many sub-prime loans have resulted in defaults. These kinds of loans are offered to people with lower credit scores and usually poor financial situations, and yet they charge higher interest rates than typical loans offered people with good credit scores. The end result is the people in more challenging financial situations end up paying extra to have credit.
Of course, if no other credit options are available – for instance in someone is recovering from bankruptcy or is dealing with incredible financial hardship – a sub-prime loan may be preferable to no loan at all. While these loans are not the best deals out there, at least they give those with poor credit histories a chance to build credit – costly as that opportunity may be.
Sub-prime loans – which carry very high interest rates – are offered to those who are most likely to default on a loan. In other words, it costs extra for these people to be given the opportunity to prove they are good borrowers because they have proven themselves to be high-risk borrowers in the past. If your mortgage broker begins his offer by saying something like, “Because of your credit history, this was the best rate I could get you…” you should suspect you are getting a sub-prime loan. You may want to ask the mortgage broker directly if this is the case.
Follow up that question with another. Ask what credit scores qualify for what rates, then check your own credit score to see if you qualify for something better than the sub-prime loan. Often borrowers may qualify for a better rate, but because they don’t ask, they don’t find out until after they’ve signed – and then they have to consider refinancing, which always involves closing costs and fees. Check around to see if you can get a better rate elsewhere before committing to a sub-prime loan.
If you only qualify for a sub-prime loan, realize this might be a good chance for you to improve your credit rating, making you eligible for better rates in the future. Thirty five percent of your credit score is based on whether you make your payments on time, so only commit to debt you can handle, and make your payments reliable on time and in full. A long-term installment loan (like a mortgage or car loan) in good standing is a wonderful boost for your credit rating, but only if you make those payments on time and in full. Only take on a sub-prime loan if you are sure you can make the payments.
