With used cars, should you buy outright – or finance?
The main advantage to buying a used car is (obviously) the lower purchase price. You have let the original purchaser absorb the depreciation hit, which can amount to a mountain of money. But when you finance the purchase of a used car, you can end up losing most of the financial advantages that you thought you were getting. Here’s how:
First, they get you on the financing.
If you buy a used car on the payment plan, expect to pay more – often, a lot more – for the interest on the loan. Many new cars can be financed with no money down and 1-2 percent (or even 0 percent) interest. But current interest rates on used car loans are in the 6-7 percent range which can amount to many hundreds – even thousands – of additional dollars spent.
Why are interest rates on used car loans higher? First, the lenders know they can get away with it. Just like those shyster Payday Loan places, the used car market preys on the less affluent. Also – and more respectably – used cars contain less value (having depreciated) and the loan period is typically shorter, so the lenders hit you with a higher percentage to make the deal worth while to them.
The bottom line is, you’ll pay more to finance a used car than you would to take out a loan on a new car – and if the interest rate you’re paying is literally twice or three times (or even more) on the used car loan, it could actually make more sense to buy a new car. So – don’t fixate on the cost of just the car; you must factor in all related costs – including the cost of interest on the loan.
Which brings up a related point: Insurance.
If you buy a used car outright, you have the option of buying just basic insurance – a liability-only policy that pays for damages you may cause to someone else’s car, but doesn’t cover damages to your car. Because it’s your car – so you can assume the risk of a total loss, if you decide it’s a reasonable risk and prefer to save money on the cost of insurance.
But if you are financing, then you don’t own the car – the lender does. Until you pay it off and all liens are removed from the title, you will be required to maintain comprehensive insurance coverage that will pay for damages to the car – including total loss – in the event you wreck. The lender will require this as part of the loan deal, because they don’t want to be left holding the bag if you do have a wreck and the car is now scrap. New car loans have the same policy.
This, too, can add up to a lot of money you might not have factored into your original purchasing decision. Even just $50 additional per month (to buy a comprehensive vs. liability-only policy) works out to $600 per year. Over a three-year loan period, that’s $1,800 – not small change for most people.
Consider, too, that you could have used that $1,800 to buy more used car, had you waited a little, saved up more – and been able to make a purchase outright, in cash (and buy the lower-cost liability-only policy).
The final thing worth mentioning about financing a used car is that your monthly payments are probably going to be higher – even without factoring in the cost of money (interest). This is because the duration of the loan is typically much shorter, 2-3 years vs. the typical 5-6 year new car loan. It may actually be financially less burdensome to pay $350 per month for the next five years for a new car than it would be to come up with $500 per month for the next three years to finance a used one.
Again, don’t fixate on just the price of the car; take the whole deal into account and make your decision based on that.
Throw it in the Woods?
I’ve been both a car salesman as well as a car dealer finance manager during my many years in the car business.
There are many factors to consider in the new versus used vehicle purchase analysis – and there is no one right answer for everyone – but a new vehicle loan at 0% or 1.9% interest will certainly save the purchaser thousands over the life of the vehicle loan, versus a used vehicle loan of the same amount of borrowed money at a higher loan interest rate.
There are plenty of free online loan calculators available, so these calculations are easy enough to do. Unfortunately, most consumers do little to no research prior to purchasing vehicles, so they are usually at least somewhat at the mercy of whatever car dealership they visit and purchase at.
My only major disagreement with your article Eric is that, at least here in Pennsylvania, depending on the consumers’ credit rating, loans of up to 60 or 72 months are as readily available on late model used vehicles as they are on new ones.
There is at least one excellent website dedicated to educating consumers on how to intelligently purchase vehicles, and how and where to do all of their research in advance of their purchases. I spent decades referring potential buyers to such websites and almost no one ever bothered to visit them. So much for trying to educate the American consumer.
Has anyone heard of the economic theory of used cars, a chap won the nobel prize for his work, Akerlof’s paper uses the market for used cars as an example of the problem of quality uncertainty. A used car is one in which ownership is transferred from one person to another, after a period of use by its first owner and its inevitable wear and tear. There are good used cars (“cherries”) and defective used cars (“lemons”), normally as a consequence of several not-always-traceable variables such as the owner’s driving style, quality and frequency of maintenance and accident history. Because many important mechanical parts and other elements are hidden from view and not easily accessible for inspection, the buyer of a car does not know beforehand whether it is a cherry or a lemon. So the buyer’s best guess for a given car is that the car is of average quality; accordingly, he/she will be willing to pay for it only the price of a car of known average quality. This means that the owner of a carefully maintained, never-abused, good used car will be unable to get a high enough price to make selling that car worthwhile.
Therefore, owners of good cars will not place their cars on the used car market. The withdrawal of good cars reduces the average quality of cars on the market, causing buyers to revise downward their expectations for any given car. This, in turn, motivates the owners of moderately good cars not to sell, and so on. The result is that a market in which there is asymmetrical information with respect to quality shows characteristics similar to those described by Gresham’s Law: the bad drives out the good (although Gresham’s Law applies to a different situation).
It’s an interesting line of thought and I think he’s probably right up to a point. But, consider that there are many people who just want something different after “x” number of years and sell/trade for that reason. The cars weren’t abused and often were maintained regularly. I remember my mom and dad’s habits here as an example of this. They’d buy a new car about every six years or so when I was growing up, trading in the old one in the process. But they always had the car serviced, it was garage-kept and not abused by them – so whomever got it next got a good used car.
I’ve also sold a few cars myself, just because I needed to thin the herd, or get the money to buy something else, etc. Not because the car was a POS or trashed by me. I’m very fastidious about maintenance – all my stuff, from lawn mowers up. I think there are plenty of people out there like that, too.
So, I think it really comes down to evaluating the individual used car; some are good – some aren’t!