If you’re in the market for a car, you have three options: buy used, buy new or lease. If you rule out leasing and decide you want to own, you’ll have to weigh the pros and cons of new cars vs. used cars. Although the out-of-pocket cost of owning a used car is generally lower, a car loan interest rate is likely to be significantly higher for a used car than for a new car.
Why are used car loan rates higher? Here are five answers to your question so you can understand the ins and outs of car loan rates before you buy a car.
5 Reasons Used Car Loan Interest Rates Are Higher Than New Car Rates
First, review this chart to see the contrast between Capital One’s current auto loan rates for new and used cars. Then, use the chart as a reference to compare auto loans and find the best one available.
Current New and Used Vehicle Interest Rates
Rarely will two people get the same interest rate if one is buying new and the other is buying used, and there are several reasons why. Use this information to determine your vehicle needs and decide which type of auto loan is best for your needs.
Here are five reasons used car interest rates are higher than new car loan rates:
1. It’s Tricky to Appraise Used Cars
New cars lose value quickly but their depreciation is straightforward. In contrast, a used car’s value can be harder to calculate because there is a greater chance the car has mechanical problems, unreported accidents or other issues.
If a used car dealership needs to repossess a car, not knowing its value can make for a risky investment. To mitigate the inherent risk in financing older vehicles, some lenders will reserve the best auto loan rates for new car buyers. Shop around to find the best used car loan rates and explore all of the loan types available to you.
2. Lower Credit Profile Buyers Typically Buy Used Cars
Used car buyers tend to have lower credit scores, according to Edmunds, which is another reason interest rates are higher on used vehicles. Lenders make up for the inherent risk in offering subprime loans or refinance deals by charging higher interest rates, which is why auto refinance rates are often quite high. Subprime loans are auto loans reserved mostly for buyers with unestablished or damaged credit. Do your research and find the lowest used car loan rates before you apply.
3. Manufacturers Entice Buyers to Purchase New Vehicles
Many major auto manufacturers are in the business of financing new cars. Dealers serve as middlemen and take a commission on each sale — and that commission is often hidden in the financing.
Dealerships can also profit from new car sales through dealer holdbacks. A holdback is money a manufacturer pays a dealer for selling a new car. Holdbacks incentivize dealerships to focus on new car sales while allowing them to advertise cars for near-invoice prices, according to Edmunds.
4. Used Car Borrowers Default More Often
The riskiest borrowers — those who are least likely to qualify for a new car loan — are increasingly likely to default, according to USA Today. Subprime auto delinquencies rose by 22 percent over last year, putting pressure on used car dealers. Because buyers with low credit scores are less likely to be approved for new car loans, many opt for used cars.
5. Used Cars Are Riskier to Finance
Lenders also have to account for the fact that they might have to repossess some of the cars they sell. Some of those repossessions might be underwater, or upside down. An upside down car loan happens when the borrower owes more to the lender than the car is worth. When repossessing an underwater car, the lender might sue the borrower in order to make back the money lost on the vehicle’s value.
Another reason used car rates are higher is because the older your vehicle, the less your lender will be able to resell the car after repossession, according to DMV.org. A new car that is repossessed will still have a higher resale value, which will enable the lender to make back the money it lost on your defaulted loan.
Should You Buy a New or Used Car?
Although interest rates for used cars are higher, you might save more on the total cost of a used car. Cars suffer the steepest and most rapid depreciation in the first year of ownership, according to Edmunds. As the car ages, its value depreciates more slowly.
You can buy used cars for less than new, too. You might pay a higher rate on a used car because your vehicle does not depreciate as quickly as a new car, but you’ll lose less money over time on your investment. In the end, out-pocket-costs are generally the highest for new car purchases, buying used is the cheapest option, and leasing falls somewhere in between.
As you shop for vehicles for sale, review maintenance records and ask about any previous accidents. If you are in touch with the previous owner of the vehicle, inquire about any problems they encountered. Finding a used car in good mechanical condition can help you save money, regardless of the loan rate.
Barri Segal contributed to the reporting for this article.