Unlike the name suggests, an auto loan is a loan that a person borrows in order to purchase a new motor vehicle.
They are mostly structured in the form of installments and are secured by the value of the vehicle purchased.
However there are certain emergency conditions in which the borrowers find difficulty in repayment of the loan amount.
For such cases, the concept of subprime loans comes to action. Subprime auto loans can be defined as the loans that are given to the borrowers who would likely to be ineligible for regular car loans for various reasons like low credit score, low income, financial instability, etc. These loans are risky in nature hence they mostly have high rate of interest, higher fees and longer terms.a
What Are Sbprime Auto Loans?
In the finance language, subprime lending also known as second chance lending is loans given to the borrowers those have difficulty or are likely to be defaulters in maintaining the repayment schedule thus portraying the financial instability due to unemployment, medical emergencies or legal marital separation. It is a happy investment for the investors and lenders because as long as the borrower is repaying his loan, he is paying it at a higher rate of interest attached to the loan. They are mostly structured as installments and are secured with the assets.
The structure of the loan can be structured depending on the vehicle and the dealership, there might or might not be a down payment amount. The larger the down payment, the lower the principal of the auto loan, which means lower costs for the borrower and reduced risk for the lender. The interest on the other hand, is the amount of money that the lender is charging you on top of amount lent. It is essentially the “cost” of the loan, or how much the lender is charging you for the privilege of borrowing money.
But the problem arises for the lenders when the borrower is defaulter in paying the loans. This is where it gets difficult and tricky. The lender first targets the asset-backed securities and thus ceases the car. But the borrower is still stuck indebted and has to repay the loan but now he cannot use his car to the office to work! Adding to this most cars depreciate their values as they are driven for long time. So even if the car is sold it doesn’t compensate the repayment cost. And as a result some lenders take the borrowers to the court and sue them for their default in repayment. In return this adds to the misery of the borrowers.
For this sickening reason, to ensure that more borrowers can pay off their loans, lenders are offering the subprime auto loans with long repayment periods. This allows the borrowers flexibility in paying lower monthly payments. But this also adds a burden of longer monthly repayment period. And for the long loan, the less the car is worth by the end of it.
In nutshell, subprime loans have two sides of the coin. The positive side is that it can carry out high- risk loan lending to the borrowers and they can be benefited from the loan. And the negative aspect is that it can cause greater troubles to the lender even though they can be secured by asset.