A subprime loan is a riskier loan that doesn't qualify for a bank's "prime rate," which is the rate offered to their best customers.
One of the biggest mistakes borrowers can make is to set out shopping for a subprime loan, says Norma Garcia, senior attorney for Consumers Union. Instead, shop a variety of lenders and get the best rate you can, regardless of how that lender classifies you.
"Lenders can offer you only the products they have available," says Garcia. But a lot of them have subprime affiliates, so they might be able to help you out.
The definition of "subprime" will vary by lender. By marketing yourself only to subprime lenders, you don't even have the chance of a better deal. And the lender is under no obligation to tell you that you could get a lower rate.
"One of the things we find is that borrowers can be charged different rates depending on which door they walk into," says Allen Fishbein, director of housing and credit policy for the Consumer Federation of America.
Go through the wrong door, and you risk getting a more expensive loan, says John Taylor, president and CEO of the National Community Reinvestment Coalition. "If you walk into a subprime branch, they will not say, 'You've got an 800 (credit score), you've got to go uptown.' "
Start with the bank or credit union where you already have an account relationship, says Jean Ann Fox, director of consumer protection for the Consumer Federation of America. Find out what they offer and see if you qualify.
If you know your actual credit score, ask for some unofficial advice on the terms they might be able to give you. This approach would allow you to start shopping without having creditors making inquiries on your credit report. (Inquiries lower your credit score. But if you're shopping for a home or auto loan, all inquiries within a 14-day period are supposed to be treated as one query, which helps you minimize the impact.)
Next, try financial institutions that you've researched that seem to have a good track record.
"You really want to shop the prime lenders," says Michael Stegman, professor of public policy and director of the Center for Community Capitalism at the University of North Carolina-Chapel Hill. Many lenders now have subprime divisions. If you go in for a prime loan and don't qualify, they may be able to refer you to another part of the same company. Also, some lenders have community development requirements.
Consumer advocates warn that subprime borrowers are more likely to be offered disadvantageous terms. So it can literally pay to shop and compare. "If you're in a marginal area, you have to do that extra bit of due diligence," says Robert Manning, professor at Rochester Institute of Technology. Fishbein agrees, "It is only through getting a range of different offers that a borrower can get a sense of what the market is like, and what the variation in the market is like."
Stick with the names you know. While you still have to keep up your guard, you'll eliminate a lot of potential problems. Subprime credit cards, often marketed to help consumers build up a positive credit history, are a particular problem, says Taylor. "There are a lot of fly-by-night cards out there from fly-by-night companies," he says. "If you haven't heard of the bank, don't get the card. Even if you have heard of the bank, remember the card may have application fees, as well as onerous annual fees and security deposits."
If you use a mortgage broker, don't count on that as your only source of information. Even though brokers can offer loans from several lenders, they aren't required to give you the lowest rate they find and may collect commissions from the lenders, Fishbein says.
This story ran on San Diego Union Tribune on January 8, 2006.