Auto Loans

How to Finance a Used Car

Sales of used cars are higher than they’ve been in a decade, and they’re poised to go higher, according to auto industry research firm Edmunds. The rising cost of new cars, along with the increased availability of vehicles coming off leases, help make used cars an attractive proposition for many shoppers.

Some buyers might insist on that new-car smell, but many savvy consumers recognize the advantages of a used vehicle. The most obvious is cost: The average price of a new car is more than $37,000, according to LendingTree, while the average used price is about $20,000. For many families, the difference represents a significant savings and tips the balance in favor of used versus new.

Other money-saving reasons to buy used rather than new can include lower insurance cost, lower registration fees (in some states) and the ability to get more car for the money. But even with these cost savings, according to research from credit reporting agency Experian, more than 53% of consumers finance their used vehicles. It surely pays to learn as much as possible about auto financing prior to signing on the dotted line.

Basics of used-car financing

Where to find used-car financing

How to get the best used-car financing

The bottom line

Basics of used-car financing

Used is almost always cheaper than new, except in one critical area: interest rates. In general, consumers can expect to pay a higher rate of interest for a used-car loan than one for a new vehicle.

The rate for new-car financing is “about 5.84% on average [as of July 2019], since a number of the rates are subsidized by the automaker,” said Ronald Montoya, senior consumer advice editor for Edmunds. “Used-car finance rates are higher [averaging about 8.6%] since the vehicles are older and the lender takes more of a risk.”

Of course, the borrower’s credit score plays a major role in determining the rate he or she can expect to pay. Consumers with excellent credit might be able to get a rate below 4%, while those with a very poor score might pay as high as 19%. But there are a number of other factors that can come into play:

Certified pre-owned vehicles. “There are often promotional interest rates for certified pre-owned vehicles,” Montoya said. “So, while you may be paying a little more for the CPO vehicle, the lower interest rate may save you more money on finance charges than a lower-priced vehicle with a much higher rate.”

You could also consider a used car that isn’t certified from either a dealer or private seller.

Age and mileage. The older the car, the less it’s worth to the lender in the event of a loan default. Age and mileage, plus the length of the loan, the amount being borrowed and the down payment will affect the interest rate.

Money down. A down payment will almost always be required when financing a used car. More money down can mean lower interest rates and a shorter repayment schedule, as well as lower monthly payments. According to Edmunds data, the average down payment on a vehicle loan is 11.7%, but some lenders may require more.

Where to find used-car financing

There are many sources for used-car loans available to consumers, each of which has its particular advantages and disadvantages.

Banks

Pros:

  • Major banks generally offer competitive rates to borrowers with good credit scores. And if you get a used-car loan from the bank where you do business, bankers there already know you and can offer more personalized service, as well as a variety of discounts, such as those for automatic payments.
  • Banks can also provide pre-approval, allowing you to shop with a variety of sellers — you may even be able to close on a loan and receive a check the same day that you could take to the dealership or private seller.

Cons

  • Most banks are generally not going to offer the lowest interest rates.
  • They also tend to have conservative policies regarding credit scores, meaning that fewer applicants will qualify for loans.

Credit unions

Pros

  • The biggest advantage of borrowing through a credit union is that they usually offer comparatively low interest rates.
  • Credit unions also pride themselves on personalized service, and they often have more lenient credit requirements for members.

Cons

  • Although some credit unions will allow anyone to join, sometimes membership is restricted to particular groups, such as employees of a given company.
  • They also tend to have fewer branches and ATMs than banks.

Manufacturer financing

Pros

  • Some manufacturers offer financing and other incentives to buyers of certified pre-owned cars. Since these vehicles are known to be in good condition, the automaker assumes less risk and can often provide a lower interest rate — for example, at time of publication, BMW was advertising CPO financing at 1.99%, certain Chevrolet models were available at 1.9% and Subaru offered loans as low as 1.99%.

Cons

  • Although financing with a manufacturer is convenient, shoppers need to be prepared in advance by comparing rates from other sources.
  • In addition, manufacturers generally only finance CPO vehicles, and the lowest rates are often available only to buyers with great credit scores.

Dealership financing

Pros

  • Most car dealers have their own sources for loans, including large lenders and local credit unions, which can mean one-stop convenience for the buyer. This access to an array of financial institutions can give customers of different credit profiles more than one option for a loan.

Cons

  • Dealerships often get a cut of the finance transaction. “Dealer financing can be good, provided you have a basis for comparison,” noted Montoya of Edmunds. “This is why I recommend folks get pre-approved.”

Online lenders

Pros

  • Operating 24 hours a day, seven days a week, online lenders can offer fast approval, competitive rates and even pre-approvals.

Cons

  • Limited customer service: Most lending sites are designed for speedy online application and approval processes, rather than human contact.
  • They also may have higher interest rates than other sources. And these sites could be new or unknown prospects, so it’s best to stick with those with a proven track record.

Other sources for used-car financing

In addition to these sources for used-car loans, there are a number of other options available to consumers.

HELOC. The primary benefit of using a home equity line of credit to purchase a car include lower interest rates, longer terms, and lower monthly payments. On the other hand, this option means you’re putting your home at risk, as well as any closing costs that may be associated with the loan.

P2P loans. There’s also peer-to-peer financing from sources like Lending Club. With this system, you usually apply online and obtain an unsecured loan, meaning the lender won’t be able to repossess your vehicle should you default. Other advantages include possible lower interest rates for borrowers with excellent credit ratings and what amounts to pre-approval, allowing you to shop for a car anywhere you like.

One thing to keep in mind, though: peer-to-peer investors generally only lend to consumers with very good credit ratings. Those with poor, or even average, scores will likely get better rates elsewhere.

Borrowing from friends and family. Some used-car buyers might consider getting a loan from a friend or family member. This can mean favorable terms, sidestepping a credit check and avoiding a down payment. On the other hand, you and the lender are putting a personal relationship at risk.

“I don’t think it’s a good idea to get loans from a friend or family,” said Edmunds’ Montoya. “Too many things can go wrong.”

Still, if you do go this route, be sure to keep everything businesslike. Loan contracts can be found online from numerous sources, including Lawdepot.com and eforms.com. Or, better yet, consult a lawyer.

How to get the best used-car financing

Paying cash for a used car is generally the best way to go. It’s simple, fast and you save all that interest. But since most consumers need to finance their vehicles, it’s important that buyers be well prepared before getting into the loan process.

Some things to keep in mind:

  • Know your credit score. This number, which ranges from 300 to 850, not only plays an important part in determining the interest rate you’ll be offered, it could also affect whether you get a loan at all. Your credit score is available free from LendingTree, as well as from the three major credit bureaus: Equifax, Experian, and Transunion.
  • You can get a loan with poor credit. Consumers with a bad credit rating still have options for securing a used-car loan. For example, you could get a cosigner who has a good credit score; that person essentially guarantees that they’ll pay back the loan if you don’t. Some dealers even self-finance in what’s called a “buy-here, pay-here” plan, but beware: rates and prices may be high.
  • Pre-approval. Getting pre-approval for a loan can help speed up car-buying considerably. This entails submitting an application to a lender prior to shopping for a vehicle. Pre-approval can help consumers know how much they can afford to spend, provide a basis for negotiation and could even result in a lower interest rate.
  • Compare rates from a number of lenders. When shopping for a loan, it’s tempting to consider just the monthly payment, but experts like the Consumer Financial Protection Bureau (CFPB) advise buyers to look carefully at the interest rate and length of loan to get the true cost of financing. You could fill out a single online form at LendingTree and receive up to five loan offers from lenders, depending on your creditworthiness.
  • Know how much you can afford. Use an online calculator to see how much a car will cost you. Of course, your best guide will be your knowledge of your own financial situation and spending habits. But be careful not to let monthly payments alone be your deciding factor. Lower payments generally mean a longer term, which results in a lot more total interest being paid. According to Edmunds, the average term for a used-car loan is 72 months, the same as a new car, and for that length of time you could be paying almost as much in finance charges as you would on a new car.
  • Research the value of the car you want to buy. Again, numerous sources can help with this including Kelley Blue Book, Edmunds or the National Automobile Dealers Association. And when you find a car, don’t forget to get a vehicle history report from a service like Carfax, to be sure it hasn’t been in a crash or had its odometer turned back. Another important step is to have an inspection done by a qualified mechanic.
  • Consider a lease. Although many shoppers might not realize it, some dealerships offer leases on used cars, primarily CPO models. It’s not common, so the selection might be limited, but you can get a higher-end vehicle than you might be able to afford new and your monthly payment could be prices lower than buying a CPO. On the other hand, any used vehicle can mean increased maintenance costs, and it might not have all the latest bells and whistles.

The bottom line

Because a new car can lose as much as 20% or more of its value in the first year, buying a used vehicle is a smart choice for many consumers. And although paying cash can give you a bit more bargaining power and allows you to avoid finance charges, the majority of buyers will finance their used-car purchase.

Financing allows you to get more car for your money, in terms of the make and model of the vehicle, as well as its options and accessories. Taking out a loan can also let you keep more of your cash in reserve and spread out your expenses over a longer period of time.

With so many sources for used-car loans, and such a wide range of terms available, the most important thing for smart consumers is to do plenty of homework before signing on the dotted line. Remember, you’re not just shopping for a vehicle, you’re also shopping for a loan. Put as much effort into comparing finance options as you did into finding your dream car.

 

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