When searching for car loans, you may be shocked to find that used car loans have higher interest rates than new car loans. After all, used cars are supposed to be cheaper than new cars, right? So then why do you have to pay more interest on used car loans than you do on new car loans?
Well, the answer is fairly simple. As cars get older, they don't run as well. Owners of used cars may have to pay for unexpected repairs that are no longer under warranty. Because those repairs could be expensive, car owners may find it difficult to pay for both the repairs and their car loans. As a result, lenders get nervous that used car owners may have to default on their car loans, which means the lenders don't get paid. So, lenders consider used car loans to be a higher risk investment than new car loans, because it is more likely that someone owning a used car will default on their loan. To ensure that they will make money, lenders charge higher interest rates on used car loans. That way, lenders are able to make a large enough profit to make the risk worth taking.
So, if you were considering purchasing a $20,000 car with a loan, it would cost you less money to get a $20,000 new car than it would to buy a $20,000 used car. Weird, I know. But it's true. Typically, used car loan interest rates are about one percent or more higher than the interest rates on new car loans (Edgerton 86). As a result, those who have used car loans have to pay more in interest than those with new car loans.
Should You Choose a New Car Loan or a Used One?
While the difference of a percentage point in interest seems like a lot, getting a new car over a used car may not save you as much money as you think. The best way to show this is to look at a hypothetical example. Say you were going to put down a 20% down payment on either a new or used $20,000 car. That means you would pay $4,000 up front and need to borrow $16,000 through an auto loan. The current interest rates are 8% for 4-year new car loans and 9% for 4-year used car loans. If you got a new car loan, your total interest payment would be $2,749.12 ("Monthly Auto Loan Payment Calculator"). If you got the used car loan, your total interest payment would be $3,111.71 ("Monthly Auto Loan Payment Calculator").
As you can see, the 1% difference in the interest rate doesn't greatly affect how much you owe. However, the difference will vary depending on how old the used car is, where you are living and the term length of your loan. So, before making a decision, make sure you check to see how much you would save by purchasing a new car over a used car. What to Watch Out For
Sometimes, if you are looking into buying a very old car, lenders will not give you a used car loan. Instead they will give you a signature loan (Cox 40). Which wouldn't seem like a big deal, except that signature loans cost more money than car loans.
When you get a car loan, your lender uses your car as collateral. The best way to understand collateral is to think of the last time you went bowling. In order to get the bowling shoes, you had to give the bowling alley your keys, driver's license or something of value. The bowling alley made you do that because they wanted to make sure you would return your shoes. Well, lenders do the same thing. Only instead of keeping your car keys, which really wouldn't work because then there would be no point to owning your car, your lender says that if you can't make your car payments, he or she gets to take your car. Because you agree to give your lender your car if you default on your payments, your lender gives you a lower interest rate. But if you get a signature loan, your lender doesn't have any collateral. Therefore, he or she has no way to ensure he or she will get paid. So your lender charges higher interest rates on unsecured loans than he or she does on auto loans.
The reason why lenders give out signature loans instead of used car loans to people who want buy very old used cars is because the car doesn't have a very high value (Cox 40). As a result, if you defaulted on your loan, the car wouldn't be worth very much to the lender. So instead, they would rather have you pay a higher interest rate than have to worry about trying to sell an old car in the future.
If your lender tries to give you a signature loan instead of a used car loan, you may want to see how much extra it would cost you to purchase a newer car. You may be surprised when you find that a newer car will actually cost you less money because the interest rate on a new or used car loan is much lower than the interest rate on the signature loan they offer you. The best way to figure out if you will save money is to shop around. See what the interest rates are on used car loans and new car loans, and compare those rates to the rate on the signature loan. The Rest of Our Auto Loan Guide: