What a subprime car loan is and who offers them
A subprime car loan is a loan to buy a car when your credit score is below the range that traditional banks consider standard — typically below 620, though the exact cutoff varies by lender. Subprime lenders include finance companies owned by major automakers (like Ford Credit or GM Financial), independent finance companies, and some credit unions and banks that maintain subprime divisions.
The term "subprime" refers to your credit history, not to the car itself. You can buy a new or used vehicle through a subprime loan. The lender is betting that you will repay despite past missed payments, defaults, or no credit history at all. That bet costs them money, so they charge you more for it.
Subprime lending is legal and regulated. The Consumer Financial Protection Bureau oversees these loans under the Truth in Lending Act, which requires lenders to disclose the interest rate, total finance charge, and payment schedule before you sign. State laws also cap how high interest rates can go, though those caps vary widely — some states allow rates above 20 percent, while others cap them lower.
Key Takeaways
- Subprime loans charge higher interest rates than prime loans because lenders view you as higher risk, and that extra cost is built into your monthly payment and total amount paid.
- Your credit score, down payment size, the age and price of the car, and the loan term all affect the interest rate you receive, and shopping with multiple lenders can change your rate by several percentage points.
- Negative equity — owing more than the car is worth — is common in subprime loans and can trap you in a cycle of rolling debt into the next vehicle if your car is totaled or you want to sell.
- Repossession is a real risk if you miss payments, and lenders can repossess your car with minimal notice and then sell it at auction, leaving you owing the difference between what they recover and what you still owe.
- Building credit while you pay off a subprime loan is possible, and on-time payments reported to credit bureaus will improve your score over time, potentially opening the door to better rates on your next loan.
How interest rates are set on subprime loans
Your interest rate on a subprime loan depends on several factors working together. Your credit score is the starting point — the lower it is, the higher your rate. But it is not the only one. Lenders also look at your debt-to-income ratio (how much you already owe compared to what you earn), your employment history, how much you can put down, the age and mileage of the car, and the loan term you choose.
A larger down payment lowers your rate because it reduces the lender's risk. Putting down 10 to 20 percent instead of nothing can move your rate down by a full percentage point or more. The age of the car matters too — a five-year-old used car will draw a lower rate than a ten-year-old one, because older cars are worth less and more likely to need repairs you cannot afford, making default more likely.
Loan term also affects rate. A 36-month loan typically carries a lower rate than a 72-month loan for the same borrower and car, because the lender's money is at risk for less time. However, the longer term means lower monthly payments, which is why many subprime borrowers choose 60 to 84 months even though they pay more interest overall.
Shopping with multiple lenders is worth your time. Different subprime lenders use different scoring models and risk calculations. One lender might offer you 12 percent while another offers 15 percent for the same car and down payment. That difference adds thousands of dollars over the life of the loan. Dealerships often work with multiple lenders and can submit your information to several at once, though you can also approach lenders directly.
The cost of borrowing: interest, fees, and total amount paid
The interest rate is only part of what you pay. Subprime loans often carry origination fees (charged by the lender to process the loan), documentation fees, and dealer fees. These can add $500 to $2,000 to the amount you finance. Some lenders also charge a fee if you pay off the loan early, though federal law limits how much that fee can be.
The total cost difference between a prime and subprime loan is substantial. A borrower with a 750 credit score might get a 48-month car loan at 5 percent interest. A borrower with a 550 score on the same car and loan term might pay 14 to 18 percent. On a $20,000 loan, that difference means paying roughly $4,000 more in interest alone over four years, plus the added fees.
Gap insurance is often pushed by dealers on subprime loans. This insurance covers the difference between what you owe and what the car is worth if it is totaled. It is optional, not required by law, but it protects you if you are underwater on the loan (owing more than the car's value). The cost is usually $500 to $1,500 added to your loan, and whether it makes sense depends on how much you are putting down and how long your loan term is.
Negative equity and being underwater on your loan
Negative equity happens when you owe more on the car than it is worth. In subprime lending, this is common because you are often putting down less money, financing more of the purchase price, and paying a higher interest rate. A car loses value the moment you drive it off the lot — typically 10 to 20 percent in the first year — so if you financed most of the purchase price, you start underwater.
Negative equity becomes a problem if your car is totaled in an accident or you want to sell or trade it in before the loan is paid off. If your car is worth $12,000 but you still owe $15,000, you have to pay the $3,000 difference out of pocket to close the loan. Many subprime borrowers cannot do that, so they roll the negative equity into their next car loan — borrowing $3,000 more than the new car costs. This cycle repeats and makes it harder to ever get ahead.
Comprehensive and collision insurance protect you against this risk by covering the car's actual value if it is damaged. However, these coverages cost more and have deductibles, so many subprime borrowers skip them to keep payments low. That is a gamble that can backfire.
Repossession risk and what happens if you miss payments
Subprime lenders are more aggressive about repossession than prime lenders because they are already taking on higher risk. Many subprime loan contracts allow repossession after a single missed payment, though lenders often wait for two or three missed payments before acting. Once they decide to repossess, they can do so without warning — a tow truck can show up at your home, workplace, or anywhere your car is parked.
After repossession, the lender sells the car at auction. Auction prices are typically 30 to 50 percent below market value because the sale is quick and the car's history is unknown to buyers. If your car sells for less than you owe, you are liable for the difference, called a deficiency. The lender can sue you for that amount, garnish your wages, or report it to credit bureaus, damaging your credit further.
If you fall behind on payments, contact your lender when ready. Some subprime lenders offer loan modification (changing the terms to lower your payment), deferment (skipping a payment and adding it to the end of the loan), or forbearance (temporarily reducing payments). These options vary by lender and are not may provide, but asking is free and may prevent repossession.
Building credit while paying a subprime loan
One benefit of a subprime loan is that on-time payments are reported to the three major credit bureaus — Equifax, Experian, and TransUnion. Each on-time payment improves your credit score slightly. After 12 to 24 months of perfect payments, your score can improve by 50 to 100 points or more, depending on where you started and what else is on your credit report.
A higher credit score opens doors. After two years of on-time payments, you may be able to refinance your subprime loan with a prime lender at a lower rate, saving money on the remaining payments. You may also be able to get better rates on credit cards, personal loans, or your next car loan. The key is consistency — missing even one payment can erase months of progress.
Paying extra toward principal when you can also helps. If your loan allows it without penalty, paying an extra $50 or $100 per month reduces the total interest you pay and gets you out of the loan faster. This also reduces the time you are underwater on the car, lowering your risk if it is damaged.
Alternatives to subprime car loans
If your credit is poor, a subprime loan is not your only option. Credit unions sometimes offer better rates than subprime lenders, even to members with low credit scores. Credit union loans are typically smaller and have shorter terms, but the rates can be 2 to 5 percentage points lower than dealer subprime loans. You have to be a member, but many credit unions have low or no membership fees.
Buying a cheaper used car with cash or a smaller loan reduces your risk and the total amount you pay in interest. A $5,000 car bought outright or financed at a lower amount means no repossession risk and no negative equity trap. The car may be older and need repairs, but the math often works out better than financing a $20,000 car at 16 percent interest.
Co-signing is another route. If a family member with good credit co-signs your loan, the lender may offer a lower rate because they have recourse to the co-signer if you default. However, the co-signer is legally responsible for the full loan amount if you stop paying, so this only works if you trust the relationship and are confident you can pay.
What to watch for when shopping for a subprime loan
Predatory practices exist in subprime lending. Some dealers and lenders use yo-yo sales, where you drive the car home and later are told the financing fell through and you have to return it — but by then you have already signed paperwork and may owe money. Others pack the loan with unnecessary add-ons like extended warranties, paint protection, or service contracts that inflate the amount financed.
Read the loan contract carefully before signing. The Truth in Lending Act requires lenders to disclose the annual percentage rate (APR), the finance charge in dollars, the amount financed, and the payment schedule. Compare these numbers across lenders. A contract that hides fees in fine print or uses confusing language is a red flag.
Avoid lenders that pressure you to decide quickly or that refuse to give you time to review documents. Legitimate lenders expect you to read and understand what you are signing. If a dealer or lender rushes you or becomes hostile when you ask questions, walk away.
Frequently Asked Questions
Can I get a subprime car loan with no credit history?
Yes. Lenders distinguish between bad credit (missed payments, defaults) and no credit (no borrowing history). No credit is often viewed as less risky than bad credit, so you may get a better rate. You will likely need a larger down payment and may need a co-signer, but subprime lenders do work with first-time borrowers.
What credit score do I need to avoid subprime rates?
Most traditional banks and credit unions start offering prime rates around 620 to 650, though some go lower. Rates improve significantly above 700. Your exact score is one factor among many — a 580 score with a large down payment and stable income may get a better rate than a 620 score with no down payment and a new job.
Can I refinance a subprime loan to a lower rate?
Yes, if your credit improves or if interest rates drop overall. After 12 to 24 months of on-time payments, your credit score may have improved enough to may have access to for a prime loan at a lower rate. You can refinance with a different lender or sometimes with the same one. Refinancing costs money in fees, so calculate whether the savings justify the cost.
What happens if I want to sell my car before the loan is paid off?
You have to pay off the loan in full to transfer the title. If you are underwater (owe more than the car is worth), you have to cover the difference. Some dealers will roll negative equity into a new loan, but this deepens the cycle. Selling privately typically gets you more than a trade-in, reducing or eliminating negative equity.
Is gap insurance worth buying on a subprime loan?
It depends on your down payment and loan term. If you are putting down less than 10 percent and financing for 72 months or longer, you will likely be underwater for much of the loan, making gap insurance more valuable. If you are putting down 20 percent or more, the risk is lower. Compare the cost of gap insurance to your risk tolerance and financial situation.