Why do banks give out new cars loans so easily and used car loans so strictly?
I see at least 10 finance deals a day on new or used cars. A car that has been previously titled is considered used. Every time a used car comes up our bank raises its interest rates and requires more income and a higher credit score to process (also the length of the loan is shorter). Further, if the car is too old then the bank will not finance. Why?
What is the incentives for the bank to process newer car loans better? One reason is the incentives. The bank knows that if it keeps the rates for new cars low the new car dealers will continue to bank with it. Yet from the banks perspective if the income from used transactions matched new transactions wouldn’t it just be a wash for the bank? A clear advantage is seen then by the new car dealer: the rates and requirements are lower and therefore they are more likely to seem more attractive to customers.
I think this comes to one of the reasons that banks do these deals and setup the incentives for consumers: rational ignorance. When the person goes out to purchase the vehicle they focus on interest rates and monthly payments. What if instead they focused on the amount of interest paid. The rate may then not be as important and the length and amount of loans may be smaller. Since people are convinced that rate is important and focus on rate and it is viewed as a smart buying decision to focus on rate the total finance charge is ignored (largely).
This shows why banks are going to offer lower rates on the new cars because typically they are going to be more expensive and therefore make the bank a larger total finance charge. The requirements being higher are related to this system. If the bank makes the loans further unattractive for the customers then it will push them into a new car loan. I think one final issue is present here as well.
The bank is acting on moral hazard assumptions. An older car maybe close to the end of its warranty (or already past it). The bank looks at this situation and figures that if the car fails then the person may have a certain interest in simply stop paying. So the bank guards against this default by setting the incentive structure as such; however, credit scores do illustrate a slight problem. Even if the person does default they are effected in everything else they do including trying to buy a replacement car. So this doesn’t appear as quite as big of a reason.
Until there is some incentive for the banks to change their structure, very unlikely, the incentives for the people is to buy new.