People who have incurred debt, have filed for bankruptcy, or who have made financial mistakes in the past have a low credit score. A bad credit rating can have a negative effect when you need to take out a loan to pay for a home, a car, or another large purchase. Certain types of loans, called subprime loans, are offered to people with bad credit, although they come with relatively high interest rates. If you have bad credit but need to take out a loan, you should weight the benefits and the disadvantages of subprime loans.
Advantages and Disadvantages of Subprime Loans
Subprime loans can be advantageous for people with poor credit. A low credit score is not necessarily an indicator of a lack of financial responsibility, and therefore subprime lenders will look at your entire credit history and will take into account each factor that has affected your credit score. If you have both bad credit and a debt with a higher interest rate than the one offered by the subprime lender, such as excessive credit card debt, it might be in your best interest to take out a subprime loan.
However, subprime loans have a variety of disadvantages that do not make them the right choice for all borrowers.
- Subprime lenders base their interest rates on credit scores. Therefore, it can be difficult to determine if a lender is offering you a fair rate.
- Because of the high interest rates, borrowers can collect high levels of additional debt over time.
- Subprime loans have much higher interest rates than traditional lenders. For this reason, those with mid-range credit scores who can qualify for other types of loans should consider alternate types of credit.
Although subprime loans can be beneficial to those who do not qualify for other types of loans, their high interest rates can cause borrowers to incur even further debt. It is important to weight the benefits and risks of subprime loans before choosing this type of loan.