Used Car Loan Terms and Conditions Explained

A used car loan is much more complicated than a new car loan for many reasons. First, it is difficult to determine the actual value of a vehicle upon purchase when it is used. Second, used cars lose their value much quicker than new cars. This means the car, which serves as collateral on the loan, will often not be worth enough to cover the remaining loan expense in case of a default and repossession. These two complications lead to unique terms and conditions.

Assessed Value

The assessed value of a vehicle should be agreed upon by both the financier and the car's seller in order to properly finance a used car. Often times, the seller will also be the lender. However, if this is not the case, the process can be more complicated. There are two primary sources for determining a used car's value: the National Auto Dealer's Association value and the Kelly Blue Book value. Dealers are more likely to use the NADA number. Where possible, the borrower should ensure the lender and the dealer are using the same metric to determine the car's value. 

Insurance Requirements

All lenders set minimum insurance requirements on cars, whether the car is new or used upon purchase. The car is used as collateral on the loan in most car loans issued. If the car is damaged during the life of the loan, the lender still technically owns the rights to the damaged car. The lender wants to assure it is repaired to standards. Without appropriate insurance, it is less likely the borrower will restore the car due to the added expense. With a used car, the risk of damage tends to be higher because the car's parts will need replaced and repaired more often. Therefore, a lender will often require higher insurance coverage on a used car upon purchase.

Recourse Loan Requirements

If the borrower does default on the loan, the car will be liquidated to cover the remaining loan cost. Unfortunately, the car may not be worth enough on trade in to cover the remaining sum. The value of a used car depreciates at a more rapid rate than the value of a new car. As such, it is more common for a used car to fail to cover the remaining loan sum in a repossession. The borrower will likely be required to cover the remaining sum out of pocket. This is called a recourse loan, and it is less favorable for the borrower. 

Loan Length

Used car loans should be shorter than new car loans for the borrower's protection. For the same reasons listed above, a used car will depreciate in value much faster during a loan than a new car. This means it can be worth a fraction of its initial cost when a loan is finally paid off. A borrower who fails to repay the loan sum fast enough will quickly be upside down on the loan contract. This means the borrower will owe more on the loan than the car is worth, providing a negative asset on a personal balance sheet.

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