Financing a Used Car

Cars are an expensive purchase, probably the most common big ticket item that you will buy. Even people that rent usually buy a car at some point, and more often then not, these large purchases are financed.

Because cars, unlike houses are guaranteed to depreciate, loans for cars are considerably different depending on the age of the car. Presumably the reason it’s almost impossible to get a good interest rate (or loan at all) on a car that is 10-15 years old is that the car has a low value (so the bank won’t get much money) and there is a high likelihood of it not running or having any value if they need to repossess it. So if you want an older car, or especially a classic car, start saving your cash because you don’t want a loan for these.

But even with newer cars there is a sharp cliff of interest rates. You’ll almost always be able to get the best interest rate for a brand new car, especially if you finance through the dealer. You can even get 0% interest. But this is a blog about used cars, a better interest rate is probably not worth the depreciation you’ll get with a new car. So that takes us to slightly used cars. You can usually still finance through a dealer if a car is 1-3 years old. These interest rates are usually competitive with what you’d get at a credit union, and a little more favorable then a bank.

Once you get past three years old, you’re probably not going to be able to get a 7 year loan. I’d advice against a loan that large in any case, because you are likely to be upside down on the loan when you’d want to sell your car (have you driven the same car for 7 years?).

Speaking of upside down, one type of loan to almost always avoid is a balloon loan. The thinking behind these is that you don’t make a lot of money now, but in X years you’ll make a lot more and can afford the big hit at the end of the loan. These are a very bad idea because you are almost guaranteed to be upside down on your loan from day one. Even if you don’t sell your car, if your car is totalled, you usually only get the blue book value on it. It’s no fun paying on a loan when there is no car anymore.

The biggest thing to consider when getting a loan for a car is how much to put down, and what the terms of the loan will be. Crunch some numbers to make sure you’ll never be upside down on the loan. You can do this by looking up the depreciation of the car (see Edmunds.com or kbb.com). The higher the depreciation on a car, the bigger your risk. We always recommend you buy a car at the bottom of it’s depreciation curve.