Why Is the Interest Rate Higher on Used Cars?

Interest rates on used cars are often higher than those on new vehicles, a difference that can puzzle many consumers. This difference stems from various factors lenders consider when assessing the risk associated with a loan. This article explores the specific elements that contribute to elevated interest rates on used car loans.

Vehicle-Specific Risk Factors

The inherent characteristics of used cars contribute to higher interest rates. While new cars experience rapid depreciation, often losing around 20% to 23.5% of their value in the first year, used cars continue to depreciate, and their remaining value can be less predictable for lenders. This ongoing decline means the collateral for a used car loan is constantly losing value, posing a greater risk to the lender.

Used vehicles carry a higher potential for mechanical issues, unknown maintenance history, and general wear and tear compared to new ones. Age and mileage are direct indicators of this increased risk, as higher mileage signifies more wear on critical components, potentially leading to costly repairs. Lenders perceive older vehicles with higher mileage as having a shorter remaining lifespan and a greater likelihood of breakdowns, which directly impacts their reliability as collateral.

For example, vehicles 8 to 12 years old have a higher default rate of 12.3% compared to 2.5% for vehicles 0 to 3 years old. This uncertainty surrounding a used car’s future condition and value translates into a higher risk premium built into the interest rate. Some lenders set age or mileage limits, such as not financing cars older than 10-12 years or with mileage exceeding 125,000 miles, to mitigate these risks.

Collateral Value and Loan-to-Value

The financial value of a used car, particularly its role as collateral for the loan, impacts interest rates. Used cars possess a lower market value than comparable new vehicles, meaning the loan amount is secured by an asset that is less valuable from the outset. This diminished value increases the lender’s exposure if the borrower defaults.

Lenders assess the loan-to-value (LTV) ratio, calculated by dividing the loan amount by the vehicle’s actual cash value. A higher LTV indicates the borrower is financing a larger percentage of the car’s value, which presents a greater risk to the lender. For used cars, the risk of the loan amount exceeding the car’s depreciated value is elevated, especially if negative equity from a previous vehicle is rolled into the new loan. The average LTV for used car loans can exceed 100%, with recent data showing averages as high as 125% of the vehicle’s value.

Valuing a used car is more intricate and subjective than valuing a new one. The condition, mileage, optional features, and market demand for a used vehicle introduce variability. Lenders utilize various valuation guides, such as Kelley Blue Book, Edmunds, or BlackBook, to determine a car’s worth, and these tools can sometimes yield differing values. This complexity adds uncertainty for the lender, contributing to a higher perceived risk and a higher interest rate.

Borrower Credit Profile and Lender Policies

A borrower’s credit score is a determinant of the interest rate on any loan. The average credit score for a used car loan is lower than for a new car loan, with reported averages ranging from 684 to 691 for used vehicles, compared to 748 to 756 for new ones. A lower credit score signals a higher perceived risk of default to lenders, leading to higher interest rates.

For instance, in the first quarter of 2025, average used car interest rates varied based on credit tiers, ranging from approximately 6.82% for borrowers with excellent “superprime” credit (781-850) to over 21.58% for those in the “deep subprime” category (300-500). This difference highlights how a borrower’s creditworthiness directly influences the cost of financing a used vehicle. Lenders implement risk-based pricing, where higher risk borrowers are charged higher rates to compensate for the increased likelihood of loan default.

Lenders have risk models and profit margins for used car loans that differ from new car loans. They perceive used vehicles as a higher-risk asset class due to factors like accelerated depreciation and potential mechanical issues. To offset this overall risk, lenders impose higher interest rates on used car loans. The competitive landscape for used car financing may offer fewer attractive options, as manufacturer incentives like 0% APR promotions are reserved for new vehicles. This reduced competition can also contribute to higher rates for used car buyers.