When you decide to buy a secondhand vehicle, there’ s a lot of calculations going on in your head. From choosing between dealerships and privateparty sales, you need to be wellversed about the complete dos and don’ts in the entire process. Among these various aspects, one factor that I have found to be of utmost importance is -- the average finance rate for used cars and their variation.
T o delve further into this matter , I decided to begin with the basics. First up, why do lenders charge interest in the first place?
If I put it in simple words any lender who offers you finance to buy your vehicle will charge interest for three reasons:
- T o compensate for the opportunity costs that are involved during the time period when the cash is in hold with the borrower
- To compensate for inflation
- To compensate for any risk wherein the borrower might default in their payment
How Do You Calculate This Interest?
Here is an illustrative example to explain the same:
Or you can simply use our carloan calculator for the sake of simplicity This is how it goes:
Now, your next question may be do these rates vary? If so, why?
Well, they vary to provide the bank a return on their investment based on their preserved risk for each lend. Cars are used as their security . Therefore, in the event of the borrower not being able to pay back the loan, the bank will repossess the car and usually sell it at the car auctions for a reserved price to reduce their loss on the loan.
In fact, the average finance rate for used cars is higher than that of new vehicles. The older the car , the more is the rate that most lenders will offer The reason for this is they deem older cars a risk for the possible loss, if they were to sell at the auctions after beingrepossessed.
What are the various factors that affect the average finance rate of used cars?
1. Financial status of borrower
If you are opting for a used car, you might probably have a low credit score. This risk is mitigated by lenders through subprime loans or refinance deals which charge higher interest rates. Other factors that affect the rate offered by lenders are the age of the borrower , stability of employment, and residential status (rented
apartment or home ownership).
2. Amount of car loan
Another factor that affects the rate offered is the size of the loan being sought. An amount of $10,000 to $20,000 will attract a certain higher rate from the lender. Any loans which are $20,000 or higher , usually attract a lower rate. These rates depend on the lender and what's on offer.
3. Age of vehicle
Most lenders will charge the same rate for new and up to fouryears old cars. Cars over four years will usually attract a 0.5 % higher rate and pretty much go higher from this point, depending on the lender and age of the car.
4. Risky investment
Lenders consider investing on a used car to be risky . It might happen that your car has mechanical issues, stray accidents, or other problems. Now if your lender requires to repossess a car in the event of a default, not knowing its true condition can amount to a risky investment. In order to make up for such inherent risks, lenders place secondhand car loans at higher rates.
Check what DMV has to say on the interest rate on a usedcar loan:
1. Lower resale value
In the event of a repossession, your lender will have to be able to resell the car. However , a new car that is repossessed will still have a higher resale value, which will enable the lender to recover his lost money on your defaulted loan.
Indeed, as silly as it sounds, lenders use these factors as a measure of risk towards the loan being paid back and, hence, any possible loss. Here is a sample that compares rates for used and newcar loans on an average principal amount of $30000 for a term of five years:
Used car loan rates as on October 2017:
New car loan rates as of October 2017:
Yes, interest rates for used cars are higher . And you can’t avoid it. This is how the market is.
But the upside is, you can save more on the total cost of a used car . Why? Well, cars exhibit the maximum, steepest, and fastest depreciation in the first year of ownership. As the number of years increases, it starts depreciating at a slower rate. Not only this, even a layman knows that a used car comes at a lower price. So if your main intention is not to burn a hole in your pocket, then going for a secondhand vehicle is a safe option.
Let me explain this through a simple example. I compare two loans a newcar loan of $15000 at the rate of 5% per year for three years and a usedcar loan of $12000 at the rate of 5.5% for three years.
A simple online calculator reflects these following results:
My advice would be if you think that a used car is ideal for you, shop around a bit. Look for vehicles on sale by various private sale and dealership firms. Take a note of their maintenance records and enquire about any previous accidents. Try to contact the previous owner of the vehicle and ask about any issues they might have
A bit of research in the market will also enable you to land a competitive rate. And choosing a car in good condition will help you in saving money in the long run, irrespective of the finance rate.
Whenever in doubt, it is always recommended to seek counsel and advice from your accountant.