Loans
3 mins
Subprime Lending: What it is & How it Works
Author
Danny Randell
Published
Jan 12, 2022
What Does “Subprime” Mean? Prime vs. Subprime
“Prime” is the standard variable interest rate that financial institutions agree to charge borrowers. It changes frequently, and generally moves up and down in accordance with economic cycles.
“Subprime” on the other hand (literally: below prime) means that a borrower does not fall into the same category as the general population. If a borrower is classed as “subprime”, a financial institution has essentially deemed them higher risk, and will thus offer them an interest rate that is higher than the prime rate.
Who Offers Subprime Loans?
Often banks are the main source of prime loans. Banks are where you go to get your run-of-the-mill mortgage, car loan, and personal line of credit. The prime rate will play a key role in determining how much interest you’ll pay.
Subprime loans can still come from banks, but more often than not, they’ll come from lenders who specialize in loans for people who have less-than-awesome credit scores. These include payday lenders and alternative financing companies (sometimes private lenders accessed through a mortgage broker for example).
How Subprime Lending Works
Subprime lending is typically assessed based on your credit score. If your score is below a certain amount (typically in the low 600s), you may not be offered the prime interest rate and will instead need to seek out subprime rates. In the case of a mortgage, this may mean going to a broker; in the case of a car loan, a dealership may offer you a higher rate than the one they’ve advertised.
Interest on Subprime Loans
The interest on subprime loans can vary widely. In essence, where prime is usually agreed upon by major financial institutions, subprime doesn’t follow these same rules, so lenders have near complete flexibility when it comes to what interest rates they want to charge.
In Canada, the government currently makes it illegal for any lender to charge more than 60% interest. When you think that the prime rate usually hovers at somewhere less than 10% — that’s a wide range!
In general, interest beyond that of a credit card (typically 18-20%) is so high that it can be very difficult to pay back if a payment is missed; as a result, interest rates in excess of 20% should be avoided if at all possible.
Pros and Cons of Subprime
The nice thing about a subprime loan is that if your credit score isn’t looking so hot, you can still get a loan for a house or a car or whatever else you need. The unfortunate part of this equation though is that if you find yourself in a financial pinch, subprime loans often come with mega-high interest rates and can be extremely difficult to pay back.
PROS:
Easy to qualify
Widely available
CONS:
High interest
Expensive to repay
Subprime Loan Alternatives
Sometimes there is no option but to pursue a subprime loan, especially if you’re looking for a substantial amount of cash (e.g. for a mortgage), but if you just need money to cover minor or monthly expenses, there are alternatives to taking a cash advance on your pay cheque from a lender that wants up to 40% interest returned with their loan.
One of the most attractive new lending formats is something called Early Wage Access (EWA), which lets you access the money you’ve earned at your job on a prorated basis for a small monthly fee. With EWA, you’re not paying interest or even having to worry about monthly payments. Take FastForward by MoneyUp, for example. You simply pay a nominal fee on withdrawals and on your monthly repayment date, your full balance is automatically deducted from your linked bank account.
