Do Sub-Prime Lenders Charge a Premium?

Sub-prime lenders always charge a premium when they provide financing for people with less than perfect credit. While most of the headlines are reserved for sub-prime real estate mortgage lenders, there are also lenders in many other areas of lending. Understanding how and why they do this should help people borrow more wisely.

Function

Sub-prime lenders make funds available for those who have less than perfect credit reports. Often classified as A-, B, B-, C or D borrowers, people who "fit" one of these designations are often unable to borrow from banks and credit unions because of their less than optimal credit score. Lenders who offer sub-prime loan products recognize that credit problems arise for reasons other than a refusal to pay obligations on time. They have decided that making loans to these borrowers will serve many people and generate good income for the lender.

Considerations

Sub-prime lenders will always charge a premium for their loans. The major considerations are how much of a premium should a borrower pay and how is it charged. The premium may appear in the interest rate and annual percentage rate (APR), in points (1 point = 1 percent of the loan amount), processing fees or all of the above. In some cases, one-time charges like points or processing fees may be the better option. At other times, an increased APR may be a wiser choice. Consider all components of loans you're evaluating.

Warning

Most sub-prime lenders are honest and offer products that are good for the borrower (considering their credit situation) and profitable for the lender. However, borrowers must be careful to analyze all aspects of the loans they consider. For example, a loan with a slightly higher-than-market interest rate may look very attractive at first. Upon closer examination, however, a borrower might find there are points and numerous "junk" fees that also are due. These additional fees, when factored into the real APR, might result in a very high interest rate.

Benefits

Those sub-prime mortgage, auto and personal loans that are priced "correctly," but not outrageously, offer many benefits to the borrower with fair or poor credit. They provide the money needed by the borrower and offer the opportunity for the borrower to improve her credit score if she makes her agreed-upon payments on time. If a credit report is not a total disaster, this one loan may provide enough positives for the borrower to significantly increase her credit score to a level that might qualify her for a low-rate loan in the future.

Effects

Sub-prime lenders that provide fairly priced loans to borrowers with less than perfect credit provide options for continued financial prosperity and stability to local, regional and national economies. The second chances offered to credit-challenged borrowers provide opportunities to re-float their financial ships. The premium (higher interest rate or fees) charged by sub-prime lenders recognizes the increased risk they face by lending to borrowers who have credit reports showing late payments to other lenders. In normal economic periods, sub-prime lenders perform a positive and useful function.

Resources

• More Information on Sub-Prime Lenders and Borrowers