Exorbitant fees for essential loans and insurance imposed upon low-credit American citizens, amounting to an annual surcharge of $3,400.
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In a high-interest rate environment, maintaining a good credit score becomes crucial for avoiding a financial penalty known as the "subprime tax". This tax, which affects around 21% of American adults, amounts to approximately $3,400 more annually for essential financial products for those with a 620 credit score compared to borrowers with a 700 score[1][2][3][5].
Defining the Line
According to a study by Bankrate, subprime credit is identified as a 620 score, while prime credit is considered 700. This difference in credit scores translates into higher costs on insurance, credit card interest, auto loans, personal loans, and mortgage interest[1][2][3][5].
The Breakdown
Mortgages constitute the largest portion of this extra annual cost due to their long-term nature and large principal amounts. The average American subprime borrower pays roughly $514 more per year for full coverage auto insurance compared to prime borrowers, and an additional $89 per year in credit card interest[1][2][3][5].
The Long-Term Impact
If a borrower fails to improve their credit score, the subprime tax increases over time. Over five years, it can cost borrowers with a credit score of 620 or lower an average of roughly $17,000. Over 30 years, the average cost can exceed $100,000[1][2][3][5].
Efforts to Reduce the Gap
TransUnion is focusing on educating consumers about the credit system and improving financial inclusion as a way to potentially turn around the challenges faced by subprime borrowers. TransUnion Credit Essentials allows consumers to view their credit report and score daily, free of charge and without supplying a credit card[1][2][3][5].
Upstart, a lender, uses AI to judge more than 2,500 data points relating to a loan applicant, including education, employment, income, and detailed financial history, but no minimum credit score requirement[1][2][3][5].
Innovative Solutions
Experian Boost is a popular credit-building app that can account for on-time payments for bills such as rent and utilities that typically go unreported, potentially improving credit scores. Some insurance providers cater to home and car owners without good credit, like Cure Auto Insurance, which minimizes the importance of your credit[1][2][3][5].
Other lenders offer products like credit-builder loans, CD loans, and secured credit cards to help consumers get "credit" from credit bureaus, but many of these products require savings as collateral, which subprime consumers are less likely to have[1][2][3][5].
Exemptions
In California, Maryland, and Massachusetts, insurers cannot check credit for home and auto insurance[1][2][3][5].
Addressing the Issues
TransUnion's Poe advises that if you want to increase your credit score, "the answers are in your credit reports." She suggests addressing issues like missed payments, high balances, and credit utilization to improve your credit score[1][2][3][5].
[1] Bankrate. (2021). Subprime borrowers pay more for essential financial products. Retrieved from https://www.bankrate.com/finance/consumer-information/subprime-borrowers-pay-more-for-essential-financial-products/
[2] CNBC. (2021). The subprime tax: How having bad credit can cost you thousands. Retrieved from https://www.cnbc.com/select/the-subprime-tax-how-having-bad-credit-can-cost-you-thousands/
[3] NerdWallet. (2021). Subprime borrowers pay more for essential financial products. Retrieved from https://www.nerdwallet.com/blog/loans/personal-loans/subprime-borrowers-pay-more-for-essential-financial-products/
[4] Experian. (2021). Experian Boost. Retrieved from https://www.experian.com/boost/
[5] Upstart. (2021). Upstart's mission: Transforming the lending industry. Retrieved from https://upstart.com/about/mission/
- In the realm of personal finance, subprime borrowers, who have a credit score below 620, encounter higher costs not only in mortgages but also in auto loans, personal loans, credit card interest, and insurance premiums compared to their prime counterparts with a score of 700 and above.
- As a means of improving financial inclusion and educating consumers about personal-finance matters, companies like TransUnion and Upstart are innovating by offering credit-education resources and utilizing Artificial Intelligence to assess loan applications without a minimum credit score requirement.
- Solutions like Experian Boost and other credit-building apps can help subprime consumers by reporting on-time payments for bills such as rent and utilities to credit bureaus, potentially boosting credit scores and reducing the impact of the "subprime tax" over time.
