Used Car Finance: What You Need to Know

Used Car Finance: What You Need to Know
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If you're looking for a budget-friendly way to get a car, then choosing a used car can offer financial benefits like a more affordable purchase price, potentially lower insurance costs and less of an impact from depreciation. Some more good news is that you have several used car financing options to choose from if you haven't saved up enough cash for the purchase, and dealers are often willing to work with people in a variety of credit situations. Take a look at which options you have for financing a used car, what lenders will require and which loan terms to understand.

Overview of Car Financing

Whether you get your auto loan through a bank, dealership or credit union, the basics will remain the same. The lender will loan you money for the car's purchase price – minus any down payment – after they investigate your finances and determine that you're eligible for funds based on the conditions and requirements they set. That assessment of your finances – plus factors like the type of lender and car financed – will help determine the annual percentage rate you pay for interest on the borrowed money.

The lender will offer you different loan term options usually between ​24 and 84 months​. While your monthly payment amount would be lower for a longer term, your interest rate may be higher and make your car much more expensive in the long run.

Your car payments include both a portion of the loan principal amount plus the interest charged for the benefit of extending you the loan and any other applicable fees. Your loan payments have to remain current through payoff or else the lender has the right to repossess the vehicle, charge fees or file a judgment against you. In fact, they have a lien on your vehicle until payoff happens, and you often don't get the title until the lien gets released.

Comparing New and Used Car Financing

When comparing loan terms for new and used cars, you'll find that while you might need to borrow less for a used car, you usually pay a higher interest rate despite this. Part of the higher rate can be attributed to the lower resale value of a used car since it's harder for the lender to accurately determine depreciation. Used cars usually also don't come with special manufacturer's financing deals that used cars may offer.

Unlike when you buy a new car, you'll find that lenders will restrict the types of used cars you can purchase based on factors like cost, condition and age. They might also be only willing to offer a shorter loan term for used cars and make you hand over a larger down payment for approval than you would with a new car.

Understanding Used Car Qualifications

Before you start shopping around for a used vehicle, you should understand that lenders often set specific requirements for the type of used vehicles they'll finance. For example, if you want to get a car loan from a credit union for a used car that's 15 years old, has 130,000 miles or only costs $2,000, you can expect to have some difficulties. While lenders vary, many only finance used cars that are worth ​$5,000 or more​, have ​under 100,000​ miles and are ​no more than 10 years old​.

For example, Bank of America requires that financed used cars have no more than 125,000 miles, are worth at least $6,000 and don't exceed 10 years old. Capital One has the same age requirement but allows a lower minimum car value of $4,000 and a lower mileage of 120,000; the lender notes that it may be possible to buy cars up to 12 years old and with 150,000 miles under certain circumstances. Dealerships offering loans directly will have their own requirements in these areas.

Considering Financial and Personal Qualifications

Even if the used vehicle qualifies, you'll still need to show the lender you're responsible and have a suitable financial profile to get used car financing. Some of the financial criteria impact your interest rate and loan amount, and the lender uses other information about you to assess risk and loan suitability as well. Here's what your lender will likely consider:

  • Down payment​: While usually optional for people with excellent credit and who are buying new vehicles, down payments are far more common for used car purchases. If you're buying used due to trouble affording or qualifying for a new car, then you might have a credit profile that warrants putting money down to qualify at all or at least lower the loan amount needed. The down payment could run as high as ​20 percent​ of the car's price depending on the lender and vehicle, but ​$500 to $1,000​ minimum is common.
  • Minimum income​: While your income matters in any situation where you're borrowing money, you'll find that qualifying for a car with poor credit can warrant showing a minimum monthly income of ​$1,500 to $2,000​. Even if you go through a traditional lender versus seek in-house financing, the lender will need to see that you have a considerable amount of money leftover each month when considering your income and debt payments. For the best results, you won't want more than half your income to go toward all debts each month.
  • Credit score​: Having a low credit score is less of a dealbreaker when you buy a used car since there are plenty of car lots out there that work with people in tricky credit situations. However, it will still have a significant impact on what you end up paying in total for the car. A prime credit score starts at ​660​, so aim for higher than this to get better auto loan rates and to improve the likelihood of qualifying through direct lenders.
  • Personal references​: Usually only required if you're going through a bad credit lender, personal references can provide insight on how responsible you are as well as help verify your identity. They can also provide additional contact information in case you end up defaulting on your loan. Lenders can require several references.
  • Residency​: Being able to prove your home address and contact information is another key requirement for used car loans even if you have good credit.

If you're lacking in some of these requirements like the minimum income and credit score, you might have better luck with a co-signer. You can find a friend or family member willing to do this and have them take on responsibility for your car loan too. You could later refinance the loan when your income and credit improve and relieve the co-signer of the obligation.

Financing Directly Through Financial Institutions

As with buying a new car, you can usually contact your current bank – or find another one online or in-person that suits you – and apply for a used car loan directly. When compared to the other used car financing options, going this route requires more work on your part but usually is the cheapest borrowing option for those with a high enough credit score to qualify. A bank or credit union will have certain loan requirements such as setting a minimum value or price for a used car, but you might need no down payment if your finances look good.

Since the terms for used car loans you're offered can vary widely, those seeking direct financing usually spend time researching and comparing lenders and submit prequalification or preapproval requests to some different financial institutions. Doing this will allow you to provide some basic information about your finances to potential lenders and find out whether approval looks likely. Lenders that offer you preapproval provide helpful details like loan terms, amounts and interest rates that will help you with your decision.

Going this route to buy a used car means you'll need to deal with both the financial institution and dealership directly. So, you'll usually fill out more loan paperwork when you're at the dealership and need to have everything cleared with the lender before you can drive off. Payments will go to the lender directly with this option.

Financing Through Dealer-Arranged Financing

Most traditional dealerships give you the option to have financing for a used car arranged through them so that you can avoid looking into financing beforehand and buy a car as soon as you find it. In the case of dealer-arranged financing, the dealership isn't actually the lender, but rather they have connections to external lenders like credit unions and banks that can offer you financing. When you find a used car on the lot, the salesperson or someone in the dealership's credit department will take some basic financial information from you to learn about your income and employment.

The dealership then completes a financing application to send out to potential lenders, and you'll hear about the ones willing to approve you as well as the terms they're offering you. If you decide to move forward, expect to pay a slightly higher interest rate than if you chose direct lending since the dealer adds some markup to get compensated for helping you with financing. So, while a bank might give you a 3.5 percent interest rate directly, you might pay 4.5 percent through dealer-arranged financing.

You won't need to worry about making a trip to a credit union or bank with this option since the dealer will have all the paperwork available for you to finance and buy the car in one place. Payments go to the lender rather than the dealership, just like with seeking a used car loan directly.

Financing Through In-House Programs

When you want to buy a used car through a dealership but don't have good enough credit for direct auto loans or dealer-arranged financing, you can consider an option called in-house financing or "buy here pay here" financing. This means the dealership directly loans you funds for a used car at their location, so you make payments to them.

The dealership will decide your maximum vehicle purchase affordability based on how much money you earn and other financial factors. While many of these places still pull your credit report, a low credit score doesn't automatically disqualify you. You can simply find out your approval amount, pick a vehicle on the lot and sign the papers needed to drive away in your new ride.

You can expect to have the most success getting approved with this option and experience the easiest car-buying process since you're handling everything financially through the dealership. However, you'll also pay the highest interest rate of all borrowing options and need to meet strict income requirements and possibly have at least a few hundred dollars set aside for a down payment. RoadLoans also cautions that these riskier loans might require buying cars significantly over their value or needing to agree to a vehicle disabling device inside the car due to a risk of repossession.

Financing Private Party Used Cars

If you can find a used car through a private seller in your community or online, you could benefit from a better deal than what you can find through various dealerships as well as potentially find a reliable car that the owner has taken care of over the years. However, this car purchase option is less straightforward for financing since the car seller probably won't loan you money. Instead, you can look into both private party auto loans and personal loans available through financial institutions like Bank of America and Lightstream.

Private party loans compare to regular auto loans since they use your car as collateral. The bank will pay the seller the amount due for the car, and you make monthly payments for a set term. These special loans usually have higher interest rates than regular car loans but lower rates than personal loans. However, you'll have to check your lender's requirements since you'll often find restrictions for the vehicles eligible for private party financing as well as minimum down payment requirements.

If you're looking for something unsecured to avoid the risk of repossession, you could go for a personal loan since you can usually use such funds for anything you want. You won't have to worry about meeting specific vehicle requirements either since your lender will just consider your financial and credit information. Beware, though, that you can get a high interest rate with this option, and there's a chance you might not qualify for a high enough loan amount or long enough loan term as you'd like.