Subprime Auto Loans: Understanding the Risks and Finding Safer Alternatives
Recently, 41 states reached a massive $710 million settlement with auto finance company Credit Acceptance (CAC). The settlement resolved allegations that CAC approved subprime automobile loans for borrowers it knew, or should have known, couldn't afford to repay those loans.
The settlement illustrates the worst case scenario for subprime auto loans, but even under the best circumstances subprime loans are extremely risky. If you need to buy a car soon and you're worries that your credit isn't good enough, here's what you need to know.
What is a subprime auto loan?
"Subprime" financing is a general term for any lending product offered to a consumer who's considered to be a high credit risk.
You may remember that subprime mortgages were at the center of the 2008 financial collapse, when lenders were essentially trying to approve as many mortgages as possible in order to bundle those mortgages together into securities. Creating more mortgages meant approving loans for borrowers with less than stellar credit, and in some cases, actively encouraging consumers to take out loans they simply could not afford to repay.
While the subprime auto loan situation hasn't yet reached that kind of crisis, what CAC is accused of doing is quite similar: encouraging dealers in the company's network to approve loans to borrowers even when CAC's own internal scoring system suggested that these borrowers could not afford the loan. (There are additional claims that CAC paid dealers incentives for including as many add-ons and up-charges as possible, but that's another story.)
What are the risks of a subprime auto loan?
Even with no additional shenanigans, subprime loans by default carry more risk than non-subprime loans.
Interest costs can be enormous
The number one way that most lenders offset the risk of a subprime borrower is with higher interest rates. That's true for credit cards, mortgages, personal loans, and auto loans.
A high interest rate on a credit card can be costly, but may not impact you too badly if you keep your balances down. That's not the case for an auto loan, which is typically in the range of $20,000 to $30,000 and beyond.
According to Experian, the average interest rate on a car loan for a borrower with excellent credit was 4.41% in Q2 2026. For subprime borrowers, the average rate was 16.11%.
Assuming both borrowers took out a loan for $25,000, the borrower with good credit would pay $2,903 in interest charges over the life of a five year loan. The borrower with poor credit, on the other hand, would pay $11,565 in interest charges, a near 300% increase.
The vehicle can become underwater quickly
An underwater loan is when the asset securing the loan is worth less than the balance remaining on the loan. Cars quite famously depreciate in value quickly. Some subprime lenders offer extended loan periods to help reduce the monthly payment, but this often increases the total interest charged over the life of the loan and increases the risk that the car will eventually be worth less than what you still owe on the loan.
This may be acceptable if your car never breaks down or needs to be replaced before the loan is paid on full. But that's a big if. And should the car need to be replaced when it's underwater you'll be out a car and still owe money on the car you can't drive anymore.
If you trade in an underwater car, you may be able to roll the remaining balance onto your next auto loan but that just increases the risk of you having to repeat the same cycle all over again.
Repossession is one slip-up away
The CAC settlement includes $388 million for borrowers who surrendered their car or lost it to repossession within the first 18 months of the loan, which is a reflection of how many borrowers were approved for car loans they were never going to be able to afford to maintain.
And that's a major issue with subprime auto loans in general: yes, it's great that borrowers who need a car and don't have great credit can get a car, but in many cases it's not a matter of if the borrower will eventually fall behind on their payments, it's a matter of when. If the car payment takes up more of your monthly budget than you can afford, it only takes one unexpected bill or even a temporary reduction in income to fall behind, often permanently.
Should you fall behind, your car may end up being repossessed, but even that doesn't end the story. If the lender sells the repossessed vehicle for less than the remaining balance on your car loan, you may end up owing a deficiency balance, once again paying money for a car you don't even own anymore.
Alternatives to subprime auto loans
Shop for financing first, then shop for a car
While it's extremely common to get your financing directly at the dealership, it's not a good way to get a competitive rate.
Instead, shop for a loan before you get to the dealership. Work with banks, credit unions, and any reputable lenders to see what kind of financing you can get. It's a bit more legwork, but it can save you a lot of money in the long run.
Pick a cheaper car
A cheaper car means a smaller loan, which means less risk for the lender and less chance of you having to rely on an expensive subprime loan.
Put down a bigger down payment
If possible, consider increasing the amount of your down payment. This reduces the size of the loan and gives you more immediate equity in the vehicle, both of which reduce risk and save money in the long term. Just don't dip into your emergency savings for the down payment.
Wait until your credit is improved
Cars are a necessity in most of America, so it may not be possible to wait if you absolutely need a car today. If you still have a working car or another way to get from point A to point B, however, you may benefit from simply waiting a bit. Use the time to improve your credit and build up a down payment.
If you have to invest a smaller amount in repairs to keep your current car on the road, weigh those costs against what it would cost you in extra interest charges to take out a subprime loan.
A subprime auto loan may be a quick solution to an immediate problem, but the risks and costs are significant, so it's best to avoid these kinds of loans whenever possible.
If credit card debt and a poor credit score are preventing you from qualifying for an auto loan, we can help. MMI's debt management plan (DMP) is proven to help consumers get out of debt 7x faster than paying on their own, and clients who have successfully completed their DMP see their credit score increase by an average of over 80 points. Try our free online financial counseling today and see if a DMP is right for you.
