If you’ve been in the market searching for a vehicle, it is likely you will have considered both a new car as well as a second hand vehicle. While each option has its respective benefits, as well as drawbacks, one area of distinction begins to emerge once you seek out finance.
It won’t take you long to realise that loans for second hand vehicles have a higher interest rate. But why, you ask? Well, the short answer is that a used car comes with a lot more risk to the financier. The more detailed answer relies on a series of considerations that we’ll cover below.
Second hand vehicles have already depreciated
When it comes to a new car, depreciation kicks in once it leaves the showroom. In contrast, a second hand vehicle has already depreciated significantly and therefore comes with a lower price-tag. Since this discrepancy eats into the earnings of a financier, they will offset this by charging a higher interest rate on the used car loan.
The valuation of a second hand vehicle is more complex
There are a lot more ‘moving parts’ when it comes to valuing a second hand vehicle. Even if the car has been mechanically cleared, it is at a greater disposition to repairs and maintenance than a brand new car. In addition, valuation will vary with the age of the vehicle. Since the car may well be used as security when the loan is established, the added complexity of a valuation imposes risk on the financier.
Second hand vehicles are more difficult to sell
If the lender needs to repossess the vehicle, they will have a harder time trying to recoup the value of the loan when selling the car. Not only does it become harder to sell vehicles as they age (collector vehicles aside), the next buyer has an advantage as far as the sale being a distressed asset. With this it makes sense that a lender will try to hedge their risk through higher interest costs.
Car loans for second hand vehicles are generally shorter
Because used cars typically have a shorter loan term, financiers will look to offset the interest payments they lose on a longer term by charging more up front. Of course you can seek a longer loan term, however because used cars typically have a lower value, the longer you are trapped in debt, the more it will inevitably cost you to pay off the car.
Most buyers of second hand vehicles have a lower credit score
Financiers need to differentiate their interest costs to align their risk profile between car buyers with a high credit score, and those with a lower credit score. Generally speaking, borrowers for second hand vehicles will have a lower credit score, and are therefore charged a higher rate to balance the lender’s loan portfolio.
The Fincar team is here to help you with all your financing needs. Contact us today to help arrange your next car or equipment loan.