Subprime car loans and bad credit finance explained

Having bad credit doesn't mean you can't get car finance. Here's our complete guide to subprime car loans

Everyone dreams of owning a brand new car, and modern finance deals mean that dream can become a reality for many. For some though, previous debts, late repayments, or filing bankruptcy mean their credit scores are often too low to qualify for any 0% APR deals. Thankfully, there are still ways of getting finance for your dream car, even if you have a poor credit history. Read on for our guide to subprime and bad credit car loans.

What is a subprime or bad credit car loan?

A subprime loan is simply a loan made by a lender to a party who may have more difficulty maintaining the repayment schedule than the average car buyer. In car finance there’s not a single cut off point that means a buyer suddenly becomes ‘subprime’. And while there are specific subprime car finance providers, subprime loans can also be obtained through mainstream lenders.

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There are several factors that could lead to a borrower being considered ‘subprime’ by a lender. These include a lack of credit history, previous and excessive debt, previous failures to pay debt, bankruptcy and other caveats corrosive to a person’s credit score. Any one or combination of these factors could lead to someone being refused car finance and as avenues to finance a new car close off, buyers can be funnelled towards finance deals and lenders designed to cater for subprime customers.  

To make up for the added risk, finance providers will usually add higher interest rates to their bad credit car loans. Lenders are known regularly to charge APR rates as high as 42.9 per cent to make up for the higher risk – a stark contrast to the 0 per cent APR finance rates quoted by many car manufacturers and mainstream lenders. 

Subprime car loans may also come with other additional fees, while some will have adjustable interest rates, meaning that the interest you pay on the loan isn’t fixed, but varies according to the market. This kind of deal can become very costly in the long run.

In either case, a subprime car loan will mean that as a buyer you are very likely to end up paying more over the course of the loan period to make up for the greater risk the lender is taking on.

What is dangerous about subprime loans?

The 2008 financial crisis was started by risk-taking lenders handing out subprime loans to homeowners who couldn’t pay back their mortgages. Banks then bundled these loans together and sold them as assets around the world. As owners began to default on their loans, the assets turned sour and the market collapsed. Although car finance loans have been placed into similar bundles, the Bank of England has said the risk of a crash is not as great as with the housing market.

Instead, the risk with bad credit car loans is twofold: first it’s with the car buyers. If they’ve been sold finance which they either do not understand or cannot afford in the long run, they may risk defaulting on the load. Falling behind on payments could lead to the car being repossessed, will hurt your credit score further and could lead to you being declined finance altogether.

This is the primary concern of the FCA’s current investigation – have the terms and conditions of the loan been properly explained to the customer and has the lender taken enough precautions to make sure the borrower is able to pay back their car loan.

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The second risk is to the car market in general. If a large economic shock were to take place where borrowers suddenly find themselves unable to pay their loans, car manufacturers and dealers could see major falls in revenue. Forecourts could fill with more used cars, driving down prices and damaging the car market as a whole.

The Bank of England has already raised concerns about the growing reliance on finance. A blog by an economist at the Bank of England said: “the industry’s growing reliance on PCP has made it more vulnerable to macroeconomic downturns.”

Should you avoid subprime car finance?

Not necessarily. If your credit score isn’t very high for any particular reason, but you have the finances to pay back the loan, then there is nothing wrong with a subprime car loan. All it means is that you’re probably going to pay more in interest and fees than a borrower able to buy from a dealer or lender offering standard car finance deals.

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However, there are major pitfalls that one can easily fall into in the rush to get a new car on your driveway. It’s imperative that before you sign on the dotted line you understand all of the terms and conditions of the agreement, and more importantly are able to adhere to them. Don’t take out a finance deal that you can’t afford to pay back and that means understanding exactly what the agreement is going to cost you over its entire term.

Have you ever taken out a bad credit car finance deal? Let us know in the comments section below…

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