#used auto loan rates
Consumers shopping for a used car worry they’ll end up with a lemon, but they are more likely to be saddled with a clunker-like loan.
Used-car buyers accounted for 62% of all the car loans originated during the second quarter of this year, according to data from credit bureau Experian. And these borrowers are driving away with interest rates that can be double what they would pay on a new-car loan. They also likely owe a lot more on the loan than what the car is worth.
Interest rates on used-car loans averaged 8.56% during the second quarter, compared with 4.46% for new cars, according to Experian. But a closer look at the average rates charged by credit score brackets shows that borrowers with the poorest credit scores end up paying a lot more when they buy a used car rather than a new one. Consumers with near-perfect credit received a 3.77% rate on average for a used-car loan, which was one percentage point higher than what they would pay for a new-car loan. Meanwhile, consumers with the poorest credit scores ended up with an average rate of 17.72%, more than four percentage points higher than what they’d pay on a new car loan.
These borrowers end up paying thousands of dollars in extra interest. On an $18,000 loan for a used car (roughly the average amount borrowed) at a 17.72% rate with a six-year repayment period (a typical duration), the monthly payment is $407.70, compared with $365.24 for the same loan on a new car with a 13.41% rate. The borrower with the used-car loan ends up paying almost $3,060 more in interest over the life of the loan.
Credit analysts say used-car buyers tend to have poorer credit — which is why they end up paying more. Borrowers who signed up for a used-car loan in the second quarter had an average credit score of 660, versus an average score of 749 for new-car loans, according to Experian. (These scores are based on Experian’s own scoring system, which ranges from 330 to 900.)
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Lenders incur bigger losses on used-car loans. The reason: More subprime borrowers tend to sign up for these loans, and they default more often. Net losses — that’s the loss lenders are left with after borrowers stop paying the loan and the car is repossessed and resold — exceed 7% of the total loan amount among subprime borrowers, most of whom sign up for a used-car loan, says Sanjay Wahi, a vice president and senior analyst at Moody’s Investors Service, covering bonds backed by car loans. In comparison, net losses are no more than 3% for prime borrowers, most of whom sign up for new car loans, he says.
To be sure, consumer experts often recommend purchasing a used car over a new vehicle. New cars tend to lose around 20% of their value when they are driven off the lot while a used car depreciates at a slower pace. In addition, car loans are often a bad deal whether the borrower is getting a new or used car. To begin with, they are paying interest on an asset that is depreciating. And in most cases, they end up underwater, meaning that they owe more on the loan than the car is worth from the moment they get the loan.
Used-car buyers, however, find themselves deeper underwater than their counterparts. On average, they owe 131.1% on their used-car loan compared with 110.5% for new cars, according to Experian. On a $20,000 car with 100% financing, for instance, a used-car borrower would owe $26,000 while a new-car borrower who would owe $22,100.
That’s partly because used-car buyers tend to purchase more add-ons when they buy a car. For instance, most new cars are sold with a warranty included, whereas warranties for used cars often cost extra. Their cost can be added to the dollar amount that is being financed.
The longer-term problem for these borrowers is that they could find themselves in a perpetual cycle where they are constantly underwater. This can happen if they want to sell their car and the price they get does not cover their remaining loan amount.
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