Auto Loans

How to Finance a Used Car

Some buyers might insist upon that new-car smell, but many savvy consumers recognize the advantages of a used car. The most obvious is cost — used is almost always cheaper than new — but there are also lower insurance costs, registration fees (depending on your state) and the ability to get more car for the money. You might be able to pay cash for a used vehicle, especially an inexpensive one, but there are several other ways to finance a used car. You could get your own direct financing and take it to a private seller or dealership. Or you could have the dealer obtain financing for you.

How to finance a used car

Paying cash for a used car is generally the best way to go. It’s simple, fast and you save all that interest. But more than 53% of consumers finance their used vehicles, according to credit reporting agency Experian. Here are some initial steps to take:

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. Credit scores aren’t included with your annual free credit report. You’ll need to pull them yourself, but there are ways to check them for free.

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.

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 LendingTree, the average term for a used-car loan is 65 months, nearly 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.

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.

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 and credit unions

Major banks and credit unions generally offer competitive auto loan 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. Credit unions also pride themselves on personalized service, and they often have more lenient credit requirements for members.

Online lenders

Operating 24 hours a day, seven days a week, online lenders can offer fast approval, competitive rates and even preapprovals. But keep in mind that most lending sites are designed for speedy online applications rather than human contact. They also may have higher interest rates than other sources, particularly online lenders targeting those with poor credit.

Manufacturers

Manufacturer financing isn’t just for new cars: some automakers offer financing and other incentives to buyers of certified pre-owned cars (CPOs). 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%. However, these rates are often available only to buyers with great credit scores. CPOs also tend to be more expensive than other used cars.

“While you may be paying a little more for the CPO vehicle,” said Ronald Montoya, senior consumer advice editor for Edmunds, “the lower interest rate may save you more money on finance charges than a lower-priced vehicle with a much higher rate.”

Dealerships

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. But dealers often get a cut of the finance transaction. “Dealer financing can be good, provided you have a basis for comparison,” Montoya said. “This is why I recommend folks get preapproved.”

Getting preapproval for a loan can help speed up car-buying considerably. This entails submitting an application to a lender prior to shopping for a vehicle. Preapproval 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. 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. You could fill out a single online form at LendingTree and receive up to five loan offers from lenders, depending on your creditworthiness.

Compare rates

A used car 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. According to Edmunds, the average rate for new-car financing is about 5.84% compared with 8.6% for used cars, which are older and therefore considered riskier by the lender.

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:

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.

Consider alternatives

If you have trouble qualifying for a traditional auto loan or perhaps decide you aren’t interested in buying at all, 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 preapproval, 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.

Leasing

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  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

The rising cost of new cars, along with the increased availability of vehicles coming off new-car leases, might tip the balance in favor of used versus new. Paying cash for a used car may give you a bit more bargaining power and allow you to avoid finance charges, but the majority of buyers will finance their used-car purchase.

This isn’t necessarily a bad thing — you could 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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