When it comes to getting a loan, your three-digit credit score is a major factor in determining your risk level as a borrower. Credit scores are typically categorized as excellent, good, fair, poor, or bad.
When it comes to the interest rate and terms of a loan, it is dependent on this same categorization of your credit score but is usually designated into two different categories. Those categories are prime and subprime. Prime covers the excellent and great credit scores, and subprime covers the fair, poor, and bad credit scores. There is also a super-prime designation that is sometimes used to refer to the top tier of excellent.
So, what does this mean for you if you are looking to get a credit card or a loan?
Here is a look at the main differences between prime and subprime loans.
What is a Prime Loan?
Prime loans are loans that are generally provided to those with high credit scores and are deemed low default risk to the lender. These people are often referred to as prime borrowers. A prime loan generally has characteristics including low interest rates and potentially higher loan amounts.
Here are the five main things that you should know about prime loans.
- Generally given to people with good and excellent credit
Prime loans are given to people that have a good to excellent credit history. One of the primary measures of credit will be the applicant’s credit score. Typically, the applicant will need to have a credit score of at least 670, although this could differ by lender. Consumers with good or excellent credit will generally be offered loans with interest rates well below 35.99% APR. For consumers with excellent credit, scores above 750, can expect to borrow money with single digit APRs – and may include a 0% rate.
Here are some of the factors that go into the calculations of a person’s credit score:
- Payment history - Does the person pay all their bills on time.
- Credit utilization - How much of a credit limit does a person use? Usually, one would want to keep credit utilization at under 30%.
- Credit history length - How long has the person had a credit card account open.
- Credit mix - What types of credit does the person use.
- New credit - Has the person recently opened one or more credit accounts.
- Offered by traditional lenders
When it comes to prime loans, they are typically offered by traditional lending institutions, banks, credit unions, and some credit card companies. Traditional lenders generally loan to less risky borrowers.
- Have competitive/lower interest rates
Because an applicant will have good credit, they will be able to get low loan interest rates. Depending on the loan size, this could save a person hundreds of dollars per month versus getting a subprime loan.
- Offered high loan amounts
When you qualify for a prime loan, you typically are offered a higher loan amount to borrow as they tend to be less risky.
- When approved, require lower down payments
When a loan requires a down payment, like a car or mortgage loan, those with higher credit scores tend to need a lower or no down payment to qualify.
What is a Subprime Loan?
Subprime loans are loans offered for people who do not qualify for prime loans due to having a lower credit score rating. Because of this, there are disadvantages when it comes to subprime loans. However, these types of loans help many people who need financial help but cannot qualify for a prime loan. Generally, subprime loans include interest rates well above 35.99% and depending on how poor the credit score is some lenders may charge upwards of 600% APR.
Here is a look at five things you should know about subprime loans.
- Available to people with fair or bad credit
Subprime loans are designed for those who have credit scores generally less than 670, although this could differ by lender. Usually, borrowers with a bad credit score will have some issues that may include the following:
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- Limited credit history
- High credit utilization
- Outstanding collections
- Late credit payments
- Offered by non-traditional lenders
When it comes to subprime loans, they are typically offered by non-traditional lending institutions. Subprime lenders typically have online applications and fast approval/denial timelines.
- Have higher interest rates
Subprime loans are generally available with high interest rates. Subprime borrowers are viewed as being a higher lending risk. The higher interest rates are used to protect the lender from defaults.
- Offered lower loan amounts
When someone qualifies for a subprime loan, they are typically offered a lower amount to borrow as they tend to be riskier borrowers.
- If needed, requires a higher down payment
If a loan requires a down payment, like a car or mortgage loan, those with lower credit scores typically need a higher down payment amount.
Knowing the difference between prime and subprime loans
Now that you know the difference between prime and subprime loans, if you currently have bad credit, you should focus on improving it so you can qualify for better interest rate loans.