If you’re in the market for a new vehicle, you're likely looking for something that doesn't force you to sacrifice your entire monthly salary to make your payments. The purchase price is certainly important but there are other factors to consider. Your goal should be to find a reasonably priced car and finance terms you're comfortable with.
You've heard you can save some money by buying a used car that’s several years old but you need to factor in the cost to finance it. Will you get hit with a higher interest rate that makes you wish you just went with new? We break down the perks and drawbacks of getting a car loan for both new and used vehicles so you can make the right decision.
New Car Financing
New car prices are higher than ever with the average new car surpassing $36,000. Sticker prices this high are out of reach for many car shoppers but manufacturers and dealers still need to sell cars. Enter special financing and incentives. Lenders and manufacturers are accommodating buyers and compensating for the high new vehicle prices with lower interest rates and longer loan terms.
Buying a new car offers some great perks when it comes to financing the purchase. Manufacturers often subsidize a lower interest rate as an incentive to sell more of a certain model or boost overall sales at year-end or holiday time. While the average car loan interest rate currently hovers around 4%, manufacturers will offer rates at a fraction of this number, sometimes as low as 2% or less. You should be aware of the terms for these rates since there are often restrictions and penalties for paying off the loan early, refinancing or modifying the loan in any way.
Even without manufacturer incentives, you'll usually be able to get a lower rate since lenders consider new car loans less risky than used. Although new cars depreciate quickly, their depreciation rate and future condition and residual value are much more predictable which equates to a better rate for the buyer.
Longer loan terms will be available for new car loans than for
Used Car Financing
Buying a used vehicle can be a smart choice if you want to avoid the high price points and depreciation of buying new. The average used car price at the end of 2017 stood at $19,400 which is a bargain compared to the average new car price of $36,113. Also, used cars buyers won't lose 20% of the car's value as soon as they drive off the dealership lot. Avoiding depreciation means a used car buyer will be less likely to become upside down on a loan.
The drawbacks of financing a used car often include a higher interest rate and a higher required down payment since the collateral comes with more risk to the lender. The condition of used cars is much less predictable than new and repairs are typically not covered by the manufacturer. If the vehicle becomes undrivable, the borrower is less likely to pay off the loan. In many cases, lenders will simply not finance a vehicle over a certain age regardless of its condition. There is also no access to manufacturer rates or incentives like cash back, with the exception of buying a certified pre-owned vehicle.
If you buy a certified pre-owned vehicle from a dealership, the lender will usually treat it like a new car. This is because the condition of the car is verified and manufacturers will offer special financing and a warranty on it. Unfortunately, there is a catch. Certified pre-owned vehicles may not save you much off the sticker price of buying new.
Deciding to Buy New or Used
Based on the chart above from an analysis done by ValuePenguin, the average interest rates on a used car (purple) are substantially higher than a new car (green) for 36 and 48-month loans. While average interest rates start to even out the longer the loan is stretched out, it's important to remember that many lenders simply won't offer terms longer than 48 or 60 months on a used car.
A used car offers the benefits of a lower price, less depreciation and shorter loan terms which means the loan can be paid off faster. New car shoppers enjoy paying a lower interest rate, getting dealer incentives, and more flexibility in their loan terms. Although we discourage stretching out a loan past 60 months, new car shoppers have the option to go with a longer car loan if they need it.
To decide which route to take, you should shop around for both your vehicle and the vehicle financing. Once you get financing options, you can plug them into a car loan calculator to see how much you'll be paying per month and add up what your total loan will run you. A lower purchase price doesn't always mean you'll save over the course of the loan, especially if your interest rate is significantly higher.