Why Are Subprime Car Loan Interest Rates So High?

Getting a subprime car loan could be an option for you if you have been turned down by a traditional car lender. Subprime car loans provide loans to those that have less-than-perfect credit at a higher interest rate. Here are the basics of why subprime car loans have a higher interest rate than other loans. 

Subprime Car Loans

In order to fully understand why subprime car loans have such high interest rates, you first need to understand what these types of loans are. A subprime loan means that the lender is dealing in the riskiest part of the market and makes the loans separate from traditional loans. Those with a 640 FICO score or lower will be potential clients for this market. 

Increased Risk

The lenders are going to charge more for the interest rate on these types of loans because of the increased risk. When you are dealing with people that have a credit score of less than 660, this means that you are taking on a great risk. Those with low credit scores got those scores because of their disregard to paying their debts. Regardless of what happened to cause them to not pay their bills on time, the fact remains that they are a bigger credit risk than those with higher credit scores.

Lending money to someone for a car loan is an investment for the lender. They do it so that they can make a return on their investment. One of the first rules of investment is that when you take on higher risk, you should be able to get a higher reward. Therefore, when the lender works with someone that falls into a high risk category, they are going to be asking for a higher return on their investment. 

Lack of Options

Another reason that these lenders charge so much is because they know that they can and still have plenty of business. There are quite a few people that fall into the category of not having a good credit history. These people can not get a normal car loan and therefore, they have to deal in the subprime market. When the lenders know this, they can charge a higher rate of interest and still have a steady stream of applicants that have been turned down elsewhere. Almost everyone needs a car these days and therefore, they will be willing to take any interest rate that they can get in many cases.

Risk of Default

Another factor that goes into the high interest rate is the risk of default. Many borrowers that fit into the subprime market have a high debt-to-income ratio. This combined with a bad credit score means that they are a high risk of default. As a subprime lender writes loans, they know that there is a certain amount of loans that will go into default. With this information, they have to charge the group as a whole enough money in interest so that they can still make money even with the defaults.