Why is it a bad idea to apply for a subprime loan? What follows is not MY advice, but rather the advice from credit reporting agencies like Experian, and from government watchdog agencies like the Consumer Financial Protection Bureau.
I preface today's article with that disclaimer because I want the message to be clear; applying for a subprime loan is something most consumers should think twice about doing. And that is according to the information you can find at the official sites of some major credit bureaus.
If you want to build up your credit and avoid applying for a mortgage loan, auto loan, or a personal loan with subprime terms, you can do so without putting your financial future in jeopardy.
What Major Credit Bureaus Say About Subprime Loans
Experian, TransUnion, and Equifax are the three major credit bureaus in the United States. Here’s what the Experian official site has to say about subprime loans:
“Getting a subprime loan is something like receiving a fourth-place trophy: It's a lot better than walking away empty-handed, but it's not a goal you'd likely set for yourself.”
That isn’t exactly a dire warning, but it’s not a ringing endorsement, either. What else does Experian have to say about subprime mortgage loans, subprime personal loans, and other credit?
“Subprime lenders typically require larger down payments on purchases than they require on conventional loans...” adding that, “what sets your experience apart from a similar conventional loan is cost. Over the life of the loan, you will spend considerably more on a subprime loan than you will on a conventional loan for the same amount.”
Subprime Loans Aren’t Just Aimed At People With Low FICO Scores
Equifax.com reminds consumers that just because you have a stronger FICO score doesn’t mean that you automatically qualify for a loan that is above the sub-prime category. “Good credit scores aren’t a golden ticket.
A lender may use information in your credit reports and other information included on your application, such as your income, to decide whether to grant you credit.”
Strong credit scores are a great start but if your loan repayment history is spotty, you may wind up in a situation where you either need to shop around more aggressively for a lender willing to work with your circumstances, or accept the terms of a subprime loan.
Some borrowers don’t realize that they have the option to shop around more--just because a couple of lenders aren’t willing to work with you doesn’t mean your loan goals are dead in the water.
SubPrime Loan Advice From The Consumer Financial Protection Bureau
CFPB is the nation’s consumer advocate and watchdog organization. It offers advice on how to avoid consumer fraud, fixing your credit scores without paying third parties, how to navigate the home loan process, and much more.
The agency offers the following warning about subprime mortgages in particular;
“Subprime mortgages have significantly higher interest rates than prime mortgages. This means that the payments may be significantly higher than for prime mortgages. Often, subprime mortgage loans are adjustable rate mortgages (ARMs). The interest rate on an ARM can rise significantly over time. Subprime loans may also have other risky features, such as negative amortization.”
Negative amortization is what is commonly known as being upside down on the loan, owning more than the property securing the loan is actually worth at the time.
CFPB advises that the best way you can protect yourself from a subprime loan is to work on your credit as soon as you know you want to borrow. Read your credit report, and make sure you fully understand what it is telling you and your loan officer.
Government advice in this area is similar to what we’ve already discussed above; shop around for your loan. “It’s important to shop around with multiple lenders and ask lots of questions. By comparing options from several different lenders, you’ll be able to tell when you are being offered a good deal.”
Don’t Make These Consumer Mistakes
The most common consumer mistakes when it comes to subprime loans are not shopping around to find a better deal on a non-subprime mortgage, subprime auto loan, etc. Asking two or three lenders isn’t enough for some transactions.
It is also necessary to aggressively review your credit. You can get free annual copies of your credit report (this link is for the only site authorized by federal law to offer you your official government-required free annual credit report) which you should get and review for errors, identity theft, etc.
Consumers do NOT NEED TO PAY THIRD PARTIES to fix your credit. You can raise your credit scores by paying ALL bills on time, every time, lowering your credit use (reduce your balances well below 50% on all cards over time), and avoid closing old credit accounts. You will also need to work on your debt ratio (the amount of money going out each month compared to the amount coming in) to make yourself a more attractive credit risk.
These steps sound intimidating, but there are financial counselors available who can help you. For example, those interested in buying a home should call the FHA/HUD at 1-800 CALL FHA to request a referral to a local-to-you, HUD-approved housing counselor who can provide advice and assistance on credit matters related to buying a home.
Remember that the leading causes of loan denial include a lack of a consistent record of on-time payments (you should strive for a minimum of 12 months on the record with all payments made on time), high credit card balances, and a low amount of income left over after the monthly bills are paid.