If you think that a subprime loan means a loan with rate below the currently established prime rate (3.25% as I write this), you’d be wrong. A subprime loan refers to the borrower…not the rate. A subprime borrower is someone who has difficulty qualifying for a loan at a traditional lender, like a bank. They may be a new borrower with little or no credit history. Or they could be someone who, for a variety of reasons, has had financial problems in the past. Could be you…could be me.
You may remember the sub-prime mortgage loans that caused such a crisis in the American and world economies just a few years ago. Since then, investors have been greedy to find high-yield returns in a time of low interest rates…and subprime auto loans fit that bill. They work the same way subprime mortgages did. Loans are given to folks with low credit scores at high (sometimes exorbitant) interest rates, and then a batch of loans are bundled together and sold as securities to investors like insurance companies and mutual funds.
The working poor are often aggressively targeted by companies making these loans…here’s why. Americans are dependent upon their cars. Very few of us can walk to work, and anyone who does not work and/or live in the city proper will find reliable public transportation very difficult to access. This creates a terrific incentive to make your car payment…even an outrageously high one. One investor who makes these types of loans said “you can sleep in your car, but you can’t drive your house to work.”
The New York Times said these loans are… “as much about Wall Street’s perpetual demand for high returns as it is about used cars.” There is a lot of money being made, largely on the backs of folks who can least afford to pay. The Times has a very interesting article on the subject, you can find it HERE. This link will open in a new tab and take you to a site maintained by the New York Times Company.
If there is any lesson in this, it is two-fold. One: greed has no bounds…and no conscience. Two: when you need a loan, even if your credit is damaged, look to a lender who wants a long term relationship with you, not someone who just wants to sell you a loan you may or may not be able to afford. They’re going to bundle it with a slew of other loans and then sell it as part of a package. They have no interest in servicing your loan…and they face no risk of default once the loan is sold.
There’s a latin phrase found in U.S. and British law: caveat emptor or “let the buyer beware.” This is good advice when you’re shopping for products and services…or shopping for a loan. There’s another phrase, brutally frank and not found in any law book: “there’s a sucker born every minute.” P.T. Barnum said that. It’s up to each of us to prove him wrong.