Why Are Interest Rates Higher on a Loan for a Used Car?

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Contributing Writer

Bethany Hickey is a graduate from the University of Michigan-Flint, with a bachelor’s in English-Writing. She is a content writer for Auto Credit Express, CarsDirect, and many other automotive blogs, as well as the Poetry Editor for UM-Flint’s writing magazine.


, Contributing Writer - July 29, 2020

You're probably going to be paying interest on an auto loan if your credit score is less than perfect, and you’re also likely to pay more in interest charges on a used car. We cover what determines interest rates on auto loans, and why new vehicles tend to get the best rates.

Why Lenders Charge Higher Interest Rates on Used Cars

Used cars may come with a lower sticker price compared to new ones, but you may end up paying your lender more in interest charges during the loan term. This is largely due to the fact that a used vehicle’s value is harder to pinpoint.

New cars are new (stick with us), and they're sold based on a manufacturer’s suggested retail price, or MSRP. Since they’ve never “truly” been on the road aside from test drives, being delivered to the dealership, etc., they don’t have any wear and tear and likely don’t have any underlying problems or an accident history. With a new vehicle, there’s no guessing on what its value is, since the manufacturer has already determined the price.

Used cars, on the other hand, can be a guessing game. Once a vehicle has tacked on some miles, it can be really hard to isolate a resale value. There are tons of factors that go into estimating a used car’s value, from where the vehicle is from to its year, make and model, trim level, mileage, desirability, and overall condition. Typically, however, the fewer miles a car has, the higher its resale price can be. So, when it comes to used vehicles with higher mileage, lenders see the car as risky.

When you talk to an auto lender about purchasing a used vehicle, there’s a higher risk of it losing even more value because of possible mechanical issues down the line. The more you drive your car, the less dependable it's likely to become.

More mileage leads to a lower resale value, which can cost the lender if you default and they need to repossess the vehicle to sell it later to pay off the remainder of your loan. The higher interest rate helps offset the amount a lender could lose if something happens during the loan.

Used Vehicles and Their Benefits

While a used car’s value may be harder to identify, and you may pay a little more interest charges, there are some great benefits to buying used.

First, you’re probably going to need to finance less, in most cases, than if you opt for a brand new model. The less you finance, the less you have to pay each month, which means more cash in your pocket.

Also, used vehicles have likely already seen their biggest drop in value. Once a new car has been driven for a year, it has typically lost around 20% of its value. This is called depreciation, and while there’s no stopping it, a used vehicle’s depreciation tends to slow down over time.

This means you also have less of a risk of being in a negative equity position on a used car loan. Used vehicles have already seen their biggest value drop, which means you aren’t likely to lose a ton of value in a short period of time, and you’re more likely to keep up with deprecation with your regular car payments.

Another bonus with financing a used vehicle is that, on average, they’re cheaper to insure. New cars tend to have more expensive features to replace or are at more of a risk of being stolen, which can increase your insurance premiums. While you’re required to carry full coverage on any financed car, going for a used vehicle usually means paying less on auto insurance.

Lowering Your Interest Charges

If you do decide to purchase a used car, don’t let the higher interest rate freak you out too much. There are ways to lower the amount you’d pay in interest charges.

One of the easiest ways to lower the amount you’d pay in interest charges is by having a down payment. Since auto loans are almost always simple interest loans, you’re charged interest daily based on the loan’s balance. Your interest charges each month are on the principal, so the less you finance, the less there is to be charged interest on.

You can also pay a little more each month, or make extra payments whenever you can. The quicker you pay your car loan off, the less you can be charged interest on, as well. This is also why you should go for the shortest loan term you can afford.

If you have a lower credit score and you want to qualify for a lower interest rate, you may be able to enlist a cosigner to help you. Cosigners can sometimes allow bad credit borrowers to be considered for more favorable auto loan terms, by “lending” you their good credit score. They help lower your risk as a borrower by promising to pay for the car loan in the event that you’re unable to.

Cosigners are usually a parent, family member or friend – really anyone with a good enough credit score and enough income to pay for your loan in case you can’t.

Ready for Your Next Car?

Interest charges are usually unavoidable on used car loans. Cosigners aren’t always an option to mitigate those charges, and if you have less than perfect credit, getting approved for an auto loan can be difficult in its own right.

When you're looking for a used vehicle as a bad credit borrower, one of the first steps you need to take is finding a lender for your situation. If you have credit issues, it can be difficult to find a lender willing to work with a tarnished credit score.

Though, there are bad credit lenders that have resources to assist borrowers of many types, called subprime lenders. They aren’t available everywhere, since they’re only signed up with dealerships that have a special finance department. But here at CarsDirect, we know which dealers work alongside bad credit lenders.

To get matched to a dealership near you with options for credit-challenged borrowers, fill out our free and secure car loan request form.

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, Contributing Writer

Bethany Hickey is a graduate from the University of Michigan-Flint, with a bachelor’s in English-Writing. She is a content writer for Auto Credit Express, CarsDirect, and many other automotive blogs, as well as the Poetry Editor for UM-Flint’s writing magazine.


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