Don’t Finance Your Used Car

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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.

Reprinted with permission from EricPetersAutos.com.

Eric Peters [send him mail] is an automotive columnist and author of Automotive Atrocities and Road Hogs (2011). Visit his website.

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