What are The Risks of Used Car Loans?

Used car loans provide a way for individuals interested in purchasing a pre-owned or used vehicle to obtain financing. Used car loans can be a good financing option, depending on the year, make and model of the car and whether or not there is some residual warranty or extended warranty value remaining.

Financing a used car purchase with a loan presents some risks to the borrower. Used cars have depreciated much more in value than a comparable new car. This depreciation could mean the potential for a loan that is upside down, which increase the chance of loan default or a financial hardship for the borrower.

Potential to Go Upside Down

An upside down loan is one where the value of the vehicle is less than the value of the car’s loan. This occurs particularly in tough economic times when interest rates are rising and falling unpredictably. This problem is further exacerbated when a borrower puts down little to no money on the car, resulting in a low loan-to-value ratio. Going upside down creates its own sets of risks for both the borrower and the lender. This is even more dramatic with a used car since much of its value is gone before the purchase is even made.

Default Risk

An upside down loan is one example of the condition that can cause a used car buyer to default on the loan. It becomes difficult to justify the continued servicing of a used car loan for a vehicle with no value or a value that is considerably less than the sum of payments being made on the car.

Financial Hardship for Borrower

Because different used cars retain value in different ways, a used car loan can potentially create a financial hardship for some borrowers. The interest rates, depending on the borrower and their credit scores, and other factors can cause the payments to be higher than they should be or interest rates excessive.

Used car loans should be used by a borrower without other sources of financing available to them. These loans however should be based on rates, terms and conditions that are reasonable relative to the car being purchased and in line with the vehicle’s value. Taking out a used car loan that is not in line with current interest rates (at the time of purchase) or with little or no money down may result in an adverse situation for the borrower and ultimately for the lender.

 


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