What a used car loan is and how it differs from new car financing

A used car loan is money a lender gives you to buy a car that is not brand new, with the agreement that you will pay it back over time with interest. The main difference between a used car loan and a new car loan is the interest rate you will pay and how the lender assesses the car's value.

Lenders charge higher interest rates for used cars because they depreciate faster and are harder to repossess and resell if you stop paying. A used 2019 Honda Civic, for example, will lose value more quickly than a brand new model, so the lender takes on more risk. The car itself serves as collateral — if you fail to pay, the lender can take the car back.

Used car loans also have shorter terms than new car loans. Most used car loans run 36 to 72 months (3 to 6 years), while new car loans often stretch to 84 months or longer. A shorter loan means higher monthly payments but less total interest paid over the life of the loan.

Key Takeaways

  • Used car loans typically carry higher interest rates than new car loans because used cars depreciate faster and are riskier for lenders.
  • The interest rate you receive depends on your credit score, the age and mileage of the car, and whether you make a down payment.
  • You can get a used car loan from a bank, credit union, online lender, or the dealership itself, and shopping around can save you hundreds of dollars in interest.
  • The lender will require a vehicle inspection and title check before approving the loan, and you must have insurance before you drive the car off the lot.
  • Used car loans typically last 36 to 72 months, and paying extra toward the principal can help you build equity in the car faster.

How interest rates are set for used car loans

Your interest rate depends on three main things: your credit score, the age and condition of the car, and how much money you put down. If your credit score is above 700, you will typically receive a lower rate than someone with a score below 650. A car that is 5 years old will have a lower rate than a 10-year-old car, because newer used cars hold their value better.

The size of your down payment also matters. If you put down 20 percent of the car's price, lenders see you as less risky and may offer a lower rate. If you put down nothing, the lender has to finance the full purchase price, which increases their risk. Many lenders require a minimum down payment of 10 to 20 percent for used cars.

Interest rates also vary by lender. Banks typically offer rates between 4 and 10 percent for used cars, depending on credit and the car's age. Credit unions often offer lower rates to their members. Online lenders and buy-here-pay-here dealerships (which finance cars directly) may offer rates of 12 percent or higher. Getting quotes from at least three different lenders before you buy can show you the real range available to you.

Where to get a used car loan

You have four main sources for a used car loan: banks, credit unions, online lenders, and dealerships. Each has different requirements and offers different terms.

Banks require a credit score of at least 620, though better rates go to scores above 700. You can explore online or in person. Banks typically take 2 to 5 business days to approve a loan. Credit unions are membership organizations that often offer lower rates than banks, but you must be a member to borrow. If you belong to a credit union, check their rates before going anywhere else. Online lenders like LendingClub, Upstart, and Carvana Finance approve loans quickly — sometimes within 24 hours — and work with lower credit scores, but their rates are often higher. Dealership financing is the most convenient because you can drive home in the car the same day, but dealership rates are usually the highest of all options. Dealerships also make money by marking up the interest rate, so the rate they offer you may be higher than what you would may have access to for at a bank.

The smartest approach is to get pre-approved for a loan from a bank or credit union before you visit a dealership. This gives you a firm interest rate and a budget, and it prevents the dealership from steering you toward a more expensive car or a higher interest rate.

What lenders check before approving your loan

Before a lender approves a used car loan, they will order a vehicle history report (usually a Carfax or AutoCheck report), inspect the car in person or through photos, and check the title to make sure the seller actually owns it. They will also pull your credit report to see your payment history and current debt.

The vehicle history report shows whether the car has been in accidents, had major repairs, been flooded, or been declared a total loss by an insurance company. A car with a salvage title (meaning it was once declared a total loss) will be much harder to finance, and some lenders will not touch it at all. The lender also wants to know the mileage and age of the car, because high-mileage vehicles (typically over 100,000 miles) may have a lower approved loan amount.

Your credit report tells the lender whether you have missed payments in the past, how much debt you currently carry, and how long you have had credit accounts open. A missed payment from five years ago will hurt less than one from last month. If you have recently paid off debt or opened new accounts, that can also affect your rate.

Down payments and how they affect your loan

A down payment is money you pay upfront toward the purchase price, reducing the amount you need to borrow. If a car costs $15,000 and you put down $3,000, you will borrow $12,000. Putting down more money lowers your monthly payment and the total interest you pay over the life of the loan.

Most lenders require a down payment of 10 to 20 percent of the car's purchase price. Some lenders will finance 100 percent of the purchase price if your credit is strong, but this is rare. If you have a trade-in (an old car you are selling to the dealership), the dealership will explore its value toward your down payment.

The math is straightforward: a $3,000 down payment on a $15,000 car at 6 percent interest over 60 months costs you about $2,290 in interest. If you put down $6,000 instead, you borrow only $9,000, and the interest drops to about $1,450. That $1,500 difference is real money in your pocket.

Monthly payments, loan terms, and building equity

Your monthly payment is determined by the loan amount, the interest rate, and the length of the loan. A $12,000 loan at 6 percent interest over 60 months costs about $219 per month. The same loan over 72 months costs about $187 per month, but you pay more interest overall because you are paying for longer.

Early in your loan, most of your payment goes toward interest rather than the car's value (called principal). By month 36 of a 60-month loan, you are finally paying more toward principal than interest. This is why paying extra toward the principal early on can save you significant money. If you can afford an extra $50 per month toward principal, you could pay off the loan years earlier and save thousands in interest.

You build equity in the car as you pay down the loan. Equity is the difference between what the car is worth and what you still owe. If your car is worth $10,000 and you owe $6,000, you have $4,000 in equity. This matters if you want to trade in or sell the car before the loan is paid off.

Insurance and other costs you need to know about

Before you drive a used car off the lot, you must have comprehensive and collision insurance in place. The lender will not release the loan funds until you show proof of insurance. Comprehensive insurance covers theft and weather damage; collision covers accidents. Together, they protect both you and the lender if something happens to the car.

Insurance costs vary widely based on the car's age, model, your age, driving history, and where you live. A 2018 Honda Civic might cost $100 to $150 per month to insure, while a 2010 model might cost $80 to $120. Get insurance quotes before you buy so you know the true cost of ownership.

You will also owe registration fees and taxes when you buy the car. These vary by state but typically add 5 to 10 percent to the purchase price. Some states charge sales tax on the full purchase price; others tax only the amount financed. Ask the dealership or your state's DMV what to expect.

Frequently Asked Questions

Can I get a used car loan with bad credit?

Yes, but you will pay a higher interest rate. Online lenders and buy-here-pay-here dealerships work with credit scores as low as 500, though rates may be 15 to 20 percent or higher. A larger down payment and a co-signer with better credit can help you may have access to for a lower rate.

What happens if I want to pay off my used car loan early?

You can pay it off anytime without penalty at most lenders. Paying early saves you interest because you stop paying interest once the loan is gone. Check your loan agreement to confirm there is no prepayment penalty, though these are rare for auto loans.

Should I buy a used car from a dealership or a private seller?

Dealerships are easier to finance through because they handle the paperwork and title transfer. Private sellers are often cheaper, but you will need to arrange financing separately and handle the title transfer yourself. Either way, get a pre-purchase inspection from a mechanic before you commit.

What is gap insurance and do I need it?

Gap insurance covers the difference between what you owe on the loan and what the car is worth if it is totaled. If you owe $10,000 and the car is worth $8,000, gap insurance pays the $2,000 gap. It is most useful if you put down less than 20 percent, because you are more likely to owe more than the car is worth early in the loan.

Can I refinance a used car loan later?

Yes, if your credit score improves or interest rates drop, you can refinance to a lower rate. This means taking out a new loan to pay off the old one. Refinancing makes sense if the new rate is at least 1 to 2 percent lower and you have at least 24 months left on the original loan.