What is a 'Subprime Lender'

A subprime lender specializes in lending to borrowers with weak or limited credit history. A smaller number of large lenders focus on subprime lending than do lenders who focus on prime lending. Also, the subprime loan market has more layering in the variation in terms and rates than the prime market.

BREAKING DOWN 'Subprime Lender'

Subprime lenders offer subprime loans to individuals who do not qualify for prime rate loans. By definition, all subprime loans have rates higher than the prime rate offered on conventional loans. However, subprime borrowers often have been turned down by traditional lenders because of their low credit ratings or other factors which suggest they have a reasonable chance of defaulting on the debt repayment. 

Subprime loans have a higher risk of default than loans to prime borrowers. As a result, they may have higher interest rates, higher closing costs, or require a more substantial down payment. With a term-loan, such as a mortgage, each additional percentage point of interest often translates into tens of thousands of dollars' worth of added payments, over the life of the loan.

The securities issued when subprime loans are repackaged and sold on the market tend to carry additional credit risk, but less interest rate risk than do prime loan packaged securities. This additional credit risk comes from the subprime borrowers having shorter time horizon loans, and fewer opportunities to refinance their mortgages when interest rates fall. 

Predatory Subprime Lenders

Any financial institution may offer a loan with subprime rates, but there are subprime lenders who focus on just these loans with higher interest rates. These lenders allow borrowers who have trouble accessing lower-interest rate loans the ability to access capital and grow their businesses or buy homes. 

However, there are indications that some subprime lenders use predatory lending practices to entice borrowers. Predatory lending includes any improper actions carried out by a lender to attract, induce and assist a borrower in taking a loan which carries high fees, a high-interest rate, strips the borrower of equity or places the borrower in a lower credit rated loan to the benefit of the lender. Also, these practices increase the borrower's likelihood of default.

Rampant subprime lending led to the 2007 subprime meltdown and contributed to one of the most severe recessions in decades. To avoid the possibility of another event of this nature, the Federal Deposit Insurance Corporation (FDIC) acts as industry watchdog for instances of predatory lending. They offer consumer information on their website to help consumers spot and report improper lending behaviors. 

How Subprime Lenders Evaluate Borrowers

Subprime lenders use risk-based pricing systems to calculate the terms of loans, and the interest rate, they offer to borrowers with varying credit histories. Risk-based pricing looks at factors such as a consumer’s credit score, adverse credit history, employment status and income. It does not consider factors such as race, color, national origin, religion, gender, marital status or age which is not allowed based on the Equal Credit Opportunity Act. 

Subprime borrowers typically have low credit ratings, such as a FICO score of 660 or below. To determine credit scores, the Fair Isaac Corporation weighs each category differently for each. However, in general, payment history is 35% of the score, accounts owed is 30%, length of credit history is 15%, new credit is 10%, and credit mix is 10%. 

Subprime lenders offer auto loans as well as mortgages and other types of loans. Subprime lenders may structure the financing as adjustable rate, fixed rate, interest only, or dignity subprime loans. So subprime borrowers may save money by shopping around.  

  1. Subprime Loan

    A subprime loan is a loan offered at a rate above prime to individuals ...
  2. Subprime Auto Loan

    A subprime auto loan is approved for people with substandard ...
  3. Subprime Meltdown

    The subprime meltdown includes the economic and market fallout ...
  4. Lender

    A lender makes funds available with the expectation that the ...
  5. B/C Loan

    A B/C loan is a loan to a subprime or thin file borrower.
  6. Risk-Based Mortgage Pricing

    Risk-based mortgage pricing is when a mortgage lender tailors ...
Related Articles
  1. Investing

    How Big Banks Are Slipping Back to Subprime Loans

    Big banks still face risks associated with subprime lending, albeit indirectly.
  2. Insights

    Subprime Debacle: Lenders See Rising Losses (SC)

    The delinquency rate on auto loans has increased every month since February, a sign that rising losses may be ahead
  3. Personal Finance

    Don't Get Trapped by Subprime Credit Cards

    Beware of subprime credit cards. It may be easy credit access, but can take advantage of your poor credit score and eventually catch you in a debt spiral.
  4. Investing

    Value of Subprime Credit Card Debt in Debate

    Many banks are easing out of subprime credit card debt while other financial institutions see opportunity.
  5. Investing

    The Great Recession's Impact on the Housing Market

    Home buyers should heed the warnings of why the Great Recession occurred in the first place.
  6. Insights

    Auto Delinquency Rates Near 2008 Highs

    Auto delinquency rates edge close to the peak reached during the height of the financial crisis, fueling speculation that subprime lending is rife again.
  7. Personal Finance

    Auto Loans the Next Subprime: Jamie Dimon (JPM)

    JP Morgan Chase CEO Jamie Dimon issues a prescient warning over stress in the auto loan market to investors in New York.
  8. Personal Finance

    Subprime Auto Loans: What Borrowers Should Know

    Are subprime auto loans a disaster waiting to happen?
  9. Personal Finance

    Conquering The Terms Of Your Mortgage

    Buyers with big down payments should get the best mortgage terms. Unfortunately, the equation isn't that simple.
  10. Small Business

    Lending Clubs: Better Than Banks?

    If you need to borrow money and your credit is making it tough, this new option may be just what you're looking for.
  1. How does a credit crunch occur?

    We examine the systemic and pervasive effects of a credit crunch, which occurs when a lack of funds available in the credit ... Read Answer >>
Trading Center