What is Subprime Lending?

There is a wide array of loan products that are alternatives to standard bank loans. Because banks routinely deny financing to borrowers with less-than-perfect credit, the subprime lending industry offers access to credit via similar financial products. These borrowers are considered to have a higher-than-average risk of default, with credit scores of 620 or below. Borrowers turn to subprime loans for vital access to credit when traditional financing options aren’t available.

You may have heard of subprime mortgages, but there is a variety of lending products available to consumers:

Subprime auto loans are for individuals looking to buy a car, but who aren’t approved for a traditional prime-rate auto loan. These loans often come with higher interest rates and less favorable terms compared to prime-rate loans. The car serves as collateral, meaning if the borrower defaults, the lender can repossess the vehicle.

Traditional Installment loans are unsecured loans, or loans secured by personal property, given to people with imperfect credit history. These loans tend to come with high interest rates and sharp penalties for late payments. Borrowers can use this money for a range of purposes like consolidating debt, covering medical bills, or making a large purchase. 

Community loans, often provided by community development banks or institutions, aim to serve underbanked communities or those with poor credit history. While they can have higher interest rates, they often offer more supportive terms than traditional subprime loans. 

Title loans are a type of secured loan where borrowers use their vehicle title as collateral. If they can’t repay the loan, the lender can take ownership of the vehicle. These loans can be a quick way to get cash, but they come with high fees and interest rates. Additionally, title loans do not check your credit or report to credit bureaus, so these loans do not benefit on-time payments with improved credit.

Payday loans are small, short-term loans meant to cover a borrower’s expenses until their next payday. However, their short-term nature often means high interest rates and fees. Like title loans, payday loans usually don’t check credit and don’t report to credit bureaus.

Why would a borrower opt for one of these loans?

Often, it comes down to necessity. When you need cash quickly and have exhausted traditional financing options, subprime loans can provide immediate relief. Depending on the type of loan, the borrower has an opportunity to build credit with proper repayment. But it’s important to understand the potential downsides. High-interest and late fees can make things difficult for borrowers if payments aren’t made on time. If the loan is secured, defaulting could mean losing a car or other valuable property. 

In the past, some consumer loans were sometimes seen as predatory, taking advantage of people’s financial situation or lack of financial knowledge. However, these days, with regulatory progress and the use of technology to minimize “bad actors”, the consumer lending industry is slowly losing the stigma that has been historically associated with them.

Like anything in finance, it’s all about understanding the terms and weighing the risks. If you’re considering a consumer loan, it’s important to have a clear plan to repay it and to consider alternatives like credit unions, community loans, or credit-building programs.

Technology is revolutionizing the industry

Like other industries, technology has the potential to make consumer lending more efficient, more straightforward, and friendlier to borrowers. The introduction of tech solutions is replacing rigid, one-size-fits-all practices with more personalized and flexible strategies. For example, Installmt’s proprietary algorithm designs customized payment structures for every borrower, catering specifically to their unique financial circumstances. This approach has drastically improved the lending landscape, with Installmt reducing delinquency rates by over 40% in our six years of testing, which is accompanied by reduced late fees and improvements in borrowers’ finances. This automated payment processing also frees up resources, letting lenders focus on portfolio growth, expansion, and more.

If you are a traditional installment lender, we encourage you to request a demo to learn more!