What are Subprime Rates?

wiseGEEK Writer

In lending terminology, a prime interest rate is one of the best interest rates that can be obtained for a specific type of loan. Prime rates vary on the type of loan, and would be set differently if a loan were for a car, for a revolving line of credit or for a mortgage. Subprime rates are defined as being well below prime, which means the interest rate is higher or above prime rates. Generally, people with poor credit are offered subprime loans and they may be called subprime creditors.

People with lower credit scores are typically classified in the subprime credit category.
People with lower credit scores are typically classified in the subprime credit category.

The goal of anyone attempting to borrow money is to borrow close to the prime rate, or if possible, below it. Even people with good credit may end up with a loan that is a percentage point or two above prime, but this is not really considered borrowing at subprime rates. Normally, what is mean by subprime is that there is a big difference between the present prime rate and the interest being offered with a specific loan. For example, if a prime rate on new car loans was 5% for the ideal lender, a subprime rate might be anywhere from 11-30%. The exact definition shifts all the time.

Borrowers usually qualify for subprime rates due to poor credit or very little credit history. These groups of borrowers are considered higher risk by lenders who would advance them funds because there’s a less proven track record that they’ll honor their debts.

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Lenders feel the extra interest charged in subprime rates is justified by the higher risk. The type of loan also makes a difference — any secured debt where property could be reclaimed and sold to pay the debt is less of a risk than unsecured debt on a credit card or personal loan. This is why people with imperfect credit are still advised to shop around, especially for automobile loans, as there can be significant expanse in subprime rates and some loans will be much closer to prime than others.

Of course, it’s arguable that lending at subprime rates tends to create part of the problem with repayment. If interest rates are higher, then so is debt, and it may take people longer to pay off debts. Borrowers with poor credit frequently have lower incomes and can't afford to accumulate extra debt in interest payments. Some critics see the worst subprime rates as little better than usury.

An interesting problem has emerged in recent years with middle of the road lenders failing to offer because of failures in the financial industry and fear of additional risk. This same problem has caused many lenders to reclassify credit applicants as subprime, who formerly would have been favorably viewed. These consumers, used to having paid prime rates most of their lives on loans, are shocked by the extra money it can cost to borrow at a less than optimal rate, or are frustrated by their inability to obtain loans at any rate.

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