The prime lending rate is the interest rate, which is offered to borrowers with the best credit. It may be different depending upon type of loan, and the score needed to get a prime rate, as of 2008, has begun to fluctuate. Any lender that loans money to people who don’t qualify for prime rates, and charges higher interest rates is called a subprime lender.
One of the reasons that a subprime lender charges higher interest rates is because it is loaning money to borrowers who are more likely to not pay back their loans. Greater risk of default on mortgage or bankruptcy, which might mean credit lines would go unpaid, is in part recovered by increasing interest rates to far above the prime rate. Essentially, if a borrower has imperfect credit he must pay more in interest rates and potentially fees to get credit or loans.
The term subprime lender became widely used starting in 2007. This is when the subprime mortgage crisis began to erupt in the US. Many lenders had not only charged higher interest rates but also taken on clients without truly verifying their ability to repay their home loans. The result was a high incidence of loan foreclosure, which began to have a huge impact on the rest of the financial markets, and on many state governments who lost housing taxes. Housing prices also fell dramatically, affecting all others attempting to sell homes or to retain their value.
It’s often thought that the term subprime lender refers only to mortgage companies that took huge and unjustifiable risks, but that is not the case. There are many other lenders that work with people with poor or risky status especially in the auto loan and credit card industries. Due to the 2007 subprime mortgage crisis and the subsequent near collapse of the financial markets in 2008, there have been some lending changes affecting most subprime loans.
These changes include dramatically raising interest rates for some lenders who might previously have been able to obtain a prime or near prime loan, and also raising what is considered a good credit score so that fewer people actually qualify for prime rates. Another fallout is that some people cannot obtain loans even at subprime rates. Another result is that some credit card companies have been able to raise rates on clients at any time, and for any reason, a matter that may be resolved by congressional law.
What this essentially means is that there are many more subprime lenders, if credit card lenders are taken into account. Anyone who lends money at a higher rate than prime is making a subprime loan, and since many credit card lenders have raised rates above prime, they technically fall into this group, including a number of traditional banks. This wouldn’t have been the case in the past for many of these lenders, and most people had to seek out special lenders that would take the extra risk in exchange for the borrower paying extra interest.
There is still a separation between the prime lender and subprime lender in the automobile loan industry. People with poor credit must seek out what are often called “bad credit” lenders, and these are not usually traditional lending institutions like banks. Instead they mostly operate by loaning to poor credit risk people, something banks and credit unions are unlikely to do.