New vs Used Car Loans: Why Are Used More Expensive?

Evp32/Getty It’s a great time to buy a used car, with thousands of well-cared-for off-lease vehicles hitting the market each day. But, while the cars are a great deal, you can expect to pay higher interest rates to finance them. It all boils down to a couple of factors: New car loans are often subsidized

New vs Used Car Loans

Evp32/Getty

It’s a great time to buy a used car, with thousands of well-cared-for off-lease vehicles hitting the market each day. But, while the cars are a great deal, you can expect to pay higher interest rates to finance them.

It all boils down to a couple of factors: New car loans are often subsidized by manufacturers as an incentive to move slower-selling vehicles off of dealership lots, and used car loans are more risky.

“There’s a greater risk in lending against collateral that is older,” says Greg McBride, the chief financial analyst for Bankrate.

The additional risk to the lender comes in several forms, some of which are related to the vehicle and some to used vehicle borrowers.

Lenders like certainty, and published pricing and expected depreciation on a new car allow them to more precisely price their risk. With used cars, there’s a greater variety of vehicle conditions and other factors that dictate how quickly the collateral will deteriorate in value. For example, new cars are more likely to be kept in a garage than older used cars.

Older cars are also more likely to fall into disrepair, says Bankrate’s McBride.

Lenders make up for this uncertainty by raising interest rates, increasing the down payment required, and limiting the length of the loan term. While you can find loans that go out as far as eight years on new car loans, used car terms won’t typically approach that duration.

There’s also more uncertainty that buyers will repay a loan on pre-owned cars.

“Defaults tend to be higher on a used car,” McBride tells U.S. News. “Borrowers tend to do a better job of keeping up with the payments on new cars,” he adds. Part of that has to do with the tendency of used cars to require repairs that are not covered under a manufacturer’s warranty. “If it’s sitting in the shop, people aren’t too keen on making the monthly payment,” McBride says.

That increased default risk gets priced into the interest rate.

So what can a buyer do to reduce the price of their financing?

First, says McBride, you shop around. “There’s a huge disparity in the rates that lenders charge,” he says, urging consumers to comparison shop between banks, locally and online, and credit unions. “Have your financing lined up before you go to the dealership.” That way you have an offer in your back pocket, and you’re not beholden to what they present.

Some lenders don’t charge an interest rate premium for used cars up to a certain age or vehicles that are certified by the manufacturer.

Make sure you understand your credit situation, ability to repay, and other financial obligations before you start the car-buying process. If your credit’s not perfect, take some time to improve it, as it will pay dividends down the road. Take advantage of your free annual credit report from each of the three major credit bureaus, and go over each with a fine-toothed comb looking for errors.

Finally, be prepared to make a larger down payment on a used car than you might have on a new car. The benefits are twofold. Lenders might be able to offer you a lower rate on the lower loan-to-value ratio, and you’re less likely to become upside-down on the loan if your car depreciates faster than the loan balance is reduced.

As with every other aspect of the car-buying process, information is your best friend when it comes to financing a used car. A bit of research and comparison shopping can save you a significant amount of money over the life of the loan.

In the market for a used car?  Find the best used car for you in our used car rankings. When you’re ready to buy, search more than a million used cars for sale in our used car listings.

Tags: Tips and Advice, used car buying, used car buying advice, auto loan rates, auto financing, auto loans, used car financing
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