Used car prices have been steadily rising over the past couple years due to high demand and low inventory. The average used car price reached an all-time high of $28,205 in December 2021, up 27% from 2020. With the price of used vehicles continuing to climb, more and more car shoppers are turning to used auto loans to finance their purchases.

A used auto loan is a financing option that allows you to spread out the cost of a used car over time through a lending institution like a bank, credit union, or online lender. Used auto loans come with monthly payments, interest, and loan terms just like new car loans. The key differences are that used auto loans typically have higher interest rates, shorter loan terms, and smaller loan amounts compared to new car financing.

Pros of Used Auto Loans

One of the biggest advantages of getting a used auto loan is that it allows you to get a lower monthly payment compared to financing a new vehicle. Since used cars have already depreciated significantly from their original MSRP, the loan amounts are much lower. This means lower monthly payments spread out over the loan term.

For example, you may be able to get a $15,000 used car loan with a monthly payment around $300. Whereas a new $30,000 car may have a monthly payment closer to $500. The used car loan cuts your payment almost in half.

In addition, depreciation is less of a factor with used cars. New vehicles can depreciate 20-30% in the first year alone. But a used car has already taken that big depreciation hit. While used cars do continue to depreciate, it’s at a much slower rate than brand new models. This means you don’t have to worry as much about your car losing value rapidly while you’re still paying it off.

Overall, the lower loan balances and slower depreciation of used vehicles make financing them much more affordable. You get more car for your money with lower monthly payments.

Cons of Used Auto Loans

Getting a loan for a used vehicle often comes with some drawbacks compared to financing a new car. Here are some of the main cons to consider:

• Higher Interest Rates – Interest rates are typically 0.5-2% higher for used auto loans versus new. This is because used cars are seen as higher risk investments by lenders. The older the used car, the higher the rate usually is.

• Shorter Loan Terms – Used car loans rarely go beyond 5 years, while new car loans can be 6 or 7 years. This means higher monthly payments on used cars. Lenders don’t want to finance used cars too far into their lifespan.

• Risk of Repairs and Maintenance – Unlike new cars with warranties, used cars come with no guarantee. Once purchased, any repairs or maintenance are the responsibility of the owner. This unpredictable extra cost factors into lenders’ higher interest rates on used cars.

Knowing the drawbacks of used auto loans allows buyers to make an informed decision. While used cars have pros like lower prices and faster depreciation, the cons highlight the tradeoffs versus new car financing. Weighing the pros and cons helps determine if a used car loan is the right choice.

Interest Rates

Interest rates can vary quite a bit between new and used auto loans. New cars often qualify for 0% financing from the manufacturer, making them very appealing from a monthly payment perspective. However, used cars typically have higher interest rates since there are no incentives from the manufacturer.

Your credit score plays a major role in determining your used car loan interest rate. The higher your score, the lower the rate you’ll qualify for. Here’s an overview of average used car loan rates by credit score range:

• 800+ credit score – Average 3-5% interest rate
• 700-799 credit score – Average 5-7% interest rate
• 600-699 credit score – Average 8-12% interest rate
• 500-599 credit score – Average 12-18% interest rate
• Below 500 credit score – May have difficulty getting approved

The average interest rate for a used car loan is around 5-9% for borrowers with good to excellent credit. For those with fair credit, expect rates of 10% or higher. Rates are also impacted by the age of the used car. Older used cars tend to have higher interest rates since they are seen as riskier collateral by lenders.

By shopping around with multiple lenders, you can compare interest rates and potentially save hundreds or thousands of dollars over the term of the loan. Be sure to also compare loan terms, fees, and other factors in addition to just the interest rate.

Terms

When taking out a used auto loan, you’ll typically have loan terms ranging from 36 to 60 months. Shorter term loans around 36 months will have higher monthly payments but you’ll pay less interest over the life of the loan. Longer term loans around 60 months will have lower monthly payments but you’ll pay more in interest.

The pros of a shorter 36 month loan are:

• You’ll pay off the loan faster
• You’ll build equity in your vehicle faster
• You’ll pay less interest overall

The cons are:

• Monthly payments will be higher
• May be harder to fit into your budget

The pros of a longer 60 month loan are:

• Monthly payments will be lower and easier to manage
• You can afford a more expensive vehicle
• Less money down upfront

The cons are:

• You’ll be making payments for a longer period of time
• You’ll pay significantly more interest over the life of the loan
• You may end up owing more than the car is worth if you want to trade it in or sell it after a few years

When deciding on loan terms, you’ll need to balance the monthly payment you can afford against the total interest you’ll pay. Think about how long you plan to keep the vehicle and your overall budget. A shorter term may be better if you don’t want to be paying on a 5 year old used car. But a longer term may make the payments more manageable. Shop around with lenders to see payment quotes at both ends of the spectrum.

Down Payment

When taking out a used auto loan, you will typically need to put down a larger down payment than you would with a new car loan. Most lenders require a down payment of 10-20% of the vehicle’s purchase price for a used car loan. This down payment helps reduce the lender’s risk by ensuring you have “skin in the game”.

Some options for coming up with the down payment include:

• Save up money specifically for the down payment. Try setting up automatic transfers to a separate savings account earmarked for the down payment. It may take some time to save up enough, but this ensures you have cash on hand.

• Ask for help from family members. Parents or grandparents may be willing to gift you money towards the down payment. Be sure to document any family gifts properly.

• Trade in your current vehicle. The trade-in value can directly reduce the purchase price, lowering the needed down payment amount. Shop around to get the best trade-in offer.

• Look into down payment assistance programs. Some credit unions and non-profit groups offer grants or no-interest loans to help with auto down payments for qualifying borrowers. Research options in your local area.

Coming up with a sufficient down payment is key to getting approved for a used car loan on good terms. Work on saving up over time and explore ways to reduce the needed amount through trade-ins or assistance programs. A larger down payment will lead to better loan terms and lower monthly payments.

Shopping for a Used Auto Loan

Shopping around for the best used auto loan rates and terms is crucial to getting the best deal. Here are some tips on how to find the best loan:

Compare Options from Dealers vs Banks/Credit Unions

• Dealerships often offer financing as a way to sell cars. However, their interest rates are usually higher than rates from banks or credit unions. Shop around before agreeing to dealer financing.

• Banks and credit unions will likely have lower interest rates than dealers, so check with them first. Getting preapproved gives you bargaining power.

• Online lenders are another option worth considering. They tend to offer quick approvals and competitive rates.

Get Preapproved Before Shopping

• Getting preapproved for a loan shows sellers you are a serious buyer and gets your financing lined up beforehand.

• It allows you to know your budget and interest rate before negotiating with the dealer. You’ll have stronger bargaining power if you already have financing.

• Preapprovals are typically good for 60 days. Make sure yours will still be valid through your car shopping process.

Negotiation Tips

• Negotiate the price of the car first, separate from financing. Only discuss payments after settling on a purchase price.

• If the dealer offers a lower interest rate, ask your lender to match or beat it. They likely will to win your business.

• Consider taking a shorter loan term (36 or 48 months) to get a lower rate, and pay it off early to save on interest.

• Having preapprovals from multiple lenders gives you leverage to negotiate the best possible deal.

Co-Signing

Co-signing on an auto loan involves a second person signing the loan agreement and becoming equally responsible for repaying the debt. Lenders sometimes require a co-signer when the primary borrower has little or poor credit history. Having a co-signer with a stronger credit profile makes the loan less risky for the lender.

When Co-Signers Are Required

Lenders will likely require a co-signer if the primary borrower:

• Has a limited credit history (e.g. young adults)
• Has a low credit score, below 620
• Has past issues like bankruptcies or repossessions
• Has a high debt-to-income ratio

Borrowers with short or troubled credit histories often need a co-signer to qualify for a used auto loan at reasonable interest rates.

Co-Signer Rights and Responsibilities

The co-signer takes on equal legal and financial responsibility for the loan. Their credit will be impacted by the primary borrower’s payment history.

If the primary borrower misses payments, the lender can seek repayment from the co-signer. The co-signer’s assets may be seized if the loan goes into default.

However, the co-signer has no rights to the vehicle itself. They cannot drive the car unless added to the insurance policy.

Before co-signing any loan, the co-signer should review the agreement carefully and consider the risks. Their credit could be damaged if the primary borrower fails to repay as agreed.

Alternatives to Traditional Loans

There are some alternatives to consider if you don’t want to take out a traditional auto loan from a bank or credit union. These options may provide more flexibility or better terms.

Lease Option

With a lease option, you make payments to lease the vehicle for a set period of time, usually 24-36 months. At the end of the lease, you have the option to purchase the car. Monthly payments are usually lower than traditional loan payments. However, you won’t build any equity until you purchase the vehicle at the end of the lease.

A lease option can be a good choice if you want a lower monthly payment or the option to switch cars more frequently. Just keep in mind that leasing often comes with mileage limits and the requirement to return the car in good condition. Going over the mileage limit or having excessive wear-and-tear charges can add to your final cost.

Peer-to-Peer Lending

Peer-to-peer lending connects individual borrowers and lenders directly, without going through a traditional financial institution. Borrowers create loan listings on peer-to-peer sites, specifying the amount they want to borrow and the purpose. Investors can then choose to fund all or part of the loan request.

Interest rates on peer-to-peer loans are set by the borrower based on their credit profile and desired loan amount. Rates are often lower than traditional auto loans. However, the process takes more effort on the borrower’s end to create a compelling loan listing that investors want to fund. There is also less oversight compared to a bank.

Peer-to-peer lending offers the potential for lower interest rates and gives borrowers more control. But you have to be comfortable marketing yourself and managing the loan process through an online platform versus a financial institution.

Maintaining the Loan

Once you have a used auto loan, it’s important to maintain it properly in order to avoid issues. Here are some tips:

Payment Best Practices

• Make your monthly payments on time – Late or missed payments can negatively impact your credit score and lead to penalties or repossession. Set up autopay or reminder alerts to help you remember.

• Pay more than the minimum when possible – Any extra payments go directly to the principal balance, helping you pay off the loan faster and save on interest.

• Avoid borrowing from the equity – Some lenders let you take cash out if you have equity in the vehicle. This leads to higher payments and interest costs. Only do so if absolutely necessary.

Options If Struggling

• Contact your lender immediately if you anticipate missing a payment or are struggling to make the monthly amount. They may be able to offer assistance, alternate payment plans, or deferments.

• Consider refinancing for a lower rate – If your credit has improved since getting the loan, you may qualify for better terms with a refinance. This can lower your monthly payment.

• Discuss the possibility of voluntary repossession with your lender as a last resort. This can help you avoid a forced repossession if you truly cannot afford the payments anymore.

Tips for Early Payoff

• Make an extra principal-only payment each month or whenever possible. This reduces the overall interest paid over the loan term.

• Pay lump sums like tax refunds or bonuses directly to the principal. Some lenders may charge a prepayment penalty, so check first.

• Refinance at a shorter term length if possible. You’ll have higher monthly payments but can pay off the loan faster.

• Sell or trade in the vehicle if you no longer need it. Use the proceeds to pay off the remaining balance.

Following smart payment and maintenance practices helps keep your used auto loan affordable and on track. Contact your lender right away if you anticipate any difficulties making payments.