The used-car market is enjoying an enormous surge, thanks in large part to the glut of vehicles coming off short-term leases. According to CNW Marketing/Research, in 1997 used-car sales topped $355 billion, more than 3% over 1996 figures. With the increase in used-car sales, the market has also witnessed an evolution in consumer-friendly financing and leasing options for those who buy pre-owned versus new. Here we explore the world of used vehicle finance and present information on how to best leverage your used-car dollars.

Used vs. New Auto Loans -- Higher Rates?

Until very recently, consumers interested in financing a used car were forced to pay significantly higher interest rates than those who financed a new vehicle -- even if their credit was excellent. This occurred because used-car programs were designed without considering the creditworthiness of each borrower. Lenders perceived a higher risk in doing business with a used-car borrower and generally, this translated into higher rates across the board. In addition, the used-car market was not as strong as it is today. Consequently, the value of the lender's collateral (the car itself) would be lower, making it necessary for the lender to make up the risk of default with higher rates. Higher "used-car" rates would be applied whether the vehicle was three weeks or three years old. In short,used was equated to higher risk and accompanying higher rates.

Over the years, consumers accepted this treatment. But it wasn't appropriate. Consider that a brand new car depreciates much more severely in its first few years than it does if it is gently-used during the next two or three years. From the bank's perspective, used cars make better collateral over short loan terms than do new vehicles. The reason stems from a new car's precipitous drop in value the moment after purchase. Banks historically charged higher rates for used-car loans and fortunately, the tide is turning.

A new development in the purchase of used cars is the availability of pre-owned cars with the full support of the automaker behind it. In addition to thorough inspections and reconditioning, the Volvo Certified Pre-Owned Car Program, for instance, offers affordable financing options to buyers. Participating in a program such as Volvo's helps the purchaser to navigate the finanacing maze.

There is now a growing trend among banks to charge the same rates on new- and used-car loans, provided the vehicle and loan terms meet certain conditions. In early 1998, for example, First Union Bank offered identical rates on 1997 new and used vehicles, with rates increasing only as the borrower's credit "score" declined. Indeed, as of April 17, 1998, the national average for new and used vehicle rates differed by little more than one percent. But not all lenders have followed suit and it is still common to find loans with rates up to 15.99% for older model used cars.

Used vs. New Auto Loans -- Term Lengths and Down Payments

With more people considering used-car purchases and younger vehicles available off-lease, the length of the loan becomes critical in determining the monthly payment and whether financing is affordable. For example, for a $14,000 used vehicle, at a 9.9% rate the payments leap from $354 for a 48-month loan to $645 for one that lasts 24 months. If $2,500 is put down, the monthly payment for the 24-month loan is approximately $585 -- closing the gap between the two term lengths from a $300 difference to roughly $240, but this gap is still significant. Thus, it is important for used-car buyers to have access to longer-term loans. The good news is that most banks have 60-month programs for late model used vehicles, with a few banks now offering 66-month loans. However, the older the vehicle, the less likely it will sustain for a full 60 or 66 months. In general, the older the vehicle, the shorter the maximum term length. Many lenders decrease the allowable loan term as credit rating declines.

Down payments

First consider how different payments affect your monthly budget. Experiment with the size of monthly payments for different lengths of loans at different interest rates. Click on the "Financial Calculators" button on this page to access tools to help with determining monthly payments.

There may be better uses for cash than applying it to the down payment. If smaller car payments are not a crucial issue, it may be better to have larger monthly installments and use the cash-on-hand for investing, paying off high-interest debt or making capital investments. Measure whether it is better to pay a higher down payment by determining the difference between the return on investment if the cash is invested and the decrease in car payments over the term of the loan. (Loan payment with smaller down x total months minus loan payment with larger down x total months compared with interest earned on the down.) If earnings on the interest are larger than the savings on the payments, use the cash for something other than the car.

Getting a Used Car Loan -- It's Easy to Apply

Applying for and getting a loan are two different things. It usually costs nothing to apply, but approval is not guaranteed and the interest rate will depend on your credit "score." Fortunately, there are many banks accepting applications and may cater to "sub-prime" candidates who have less-than-stellar credit histories. However, don't assume that you are a bad credit risk just because you owe money and have been occasionally late on payments. Those are not necessarily considered bad problems anymore given the state of most American's credit.

Most banks determine the credit "score" of a prospective borrower using data from one of the major credit reporting companies. You too can obtain your credit history from them-- and it is a good idea to do this once a year to make sure they haven't made any mistakes in their reporting. They are:

• TRW

• Trans Union at http://www.transunion.com

• Equifax at http://www.equifax.com

Banks rate prospective clients on their ability to pay, credit history and type of previous debt with gradings of A+, A, B, C or below. Applicants who receive a C or below are considered B-paper borrowers with a higher risk of default. B-paper borrowers can get loans but may require a co-signer or the services of a sub-prime specialist -- a bank or lender specializing in loaning money to people who are higher risks. It helps to know your credit status before shopping for a loan. Avoid wasting time with lenders who won't provide the kind of loan you need.

The most efficient way to shop for a new loan (or lease) is on the Internet. Get a general idea of rates in your area by visiting the
Bank Rate Monitor at http://www.bankrate.com.
Banks and lending institutions are easy to find by searching Yahoo or Excite. Major lenders like G.E. Capital, Ford Credit, Chase Manhattan, and Bank One all have online credit applications. Contact at least three lenders to compare rates and terms. Once you find a good lender with decent rates at an acceptable term, complete an application. Research the offerings of the lenders before filling out any applications. Apply to the best one first and see the response. It is important to limit the number of applications filed as each one queries your credit history. Each of these queries appears on your credit history. These queries can be interpreted in two ways: first that you are simply shopping for a loan or conversely that you can't get one. Just don't give anyone the opportunity to misinterpret the data.

Getting Credit Before The Purchase -- A Negotiating Advantage

Having credit approval when walking into the dealership gives most consumers a shopping advantage. Dealers receive incentives from lenders for loans they write. Dealers are motivated to write loans with the lender offering them the best incentives and not necessarily the ones with the most attractive rates for the customer. They are not trying to rip anybody off, just motivating salespeople to sell a particular financing product. It is up to you to decide whether the loan package offered is good enough. For that reason, being pre-approved for financing gives many people a leg up. After all, it's one less thing to worry about and it gives an element of control in the negotiations -- you are a "cash buyer" to the dealer. As a cash buyer, your primary concern is to haggle over the lowest possible bottom-line price. Without pre-approved financing, the additional task of comparing loan rates with the dealer'sF&I person adds unnecessary stress and potential added expenses for those who do not get the best rate available.

When shopping for advance financing, be aware that some lenders will not quote rates or offer a loan directly. They will refer you to a participating dealership, who will then quote the applicable rates. Either find a lender that will give quotes or get the whole rate story from a dealership's F&I person. In most cases, all will turn out well. With pre-approved credit comes the luxury of taking the rate the dealer offers if it is better or using the one you already have.

NOTE: All loan rates are negotiable no matter what your credit rating is. Tell the lender the rate is too high and what you can get it for elsewhere. It they need business on that day, they will often lower the rate to get yours.

I've Changed My Mind - Can I Return the Car?

In most states, when a car is bought at a dealership the buyer is committed to keeping it once delivery is taken. There are minor exceptions that vary from state to state. For example, if the car is delivered to your home or office initially, you may have three days to rescind the deal. In California, individuals who purchase and take delivery of a vehicle at the dealership have seven days to replace the financing. This law was designed to relieve Californians of the burden of shopping for credit without knowing exactly which car they intend to purchase. For the most part, however, there is no buyer's remorse for used cars because of the Federal "As Is" Law. Read "Buying Smart: Avoiding Common Used Car Shopping Problems" for additional details.

Legal Rights Under The Loan -- Do I Own The Vehicle?

When borrowing funds to purchase a vehicle, a promise is made to repay the amount borrowed (plus interest and fees), and the bank is granted a lien or security interest in the vehicle. That way, if the borrower defaults on the payments or otherwise violates the loan agreement, the bank may repossess the vehicle and auction or sell it to offset the amount owed under the promissory note. Does this mean the bank controls what you do with your vehicle? In a way, yes. While you are free to sell the vehicle at any time, if you do, you must repay the entire loan balance before transferring title to the new buyer. Some loan agreements require a minimum level of insurance. Without it you are deemed in violation of the agreement and the bank may exercise its right to repossess the vehicle. Some loans require keeping the vehicle within the country as long as money is still owed to the financing bank. If you comply with all terms of the loan, however, you are otherwise in control of the vehicle. With a lease, the lessor owns the vehicle.

Along with that privilege of ownership comes financial responsibility -- even if the car financed is a lemon or worse, if you were defrauded during the purchase of the car, you still are responsible for paying the loan. In the vast majority of cases, unless the bank itself sold the vehicle or was in complicity with a fraudulent sale, your sole recourse lies against the seller of the car -- not the bank. The loan must still be paid off, even if the seller lied and sold a wreck that ran for only two days.

Used Car Leasing - A Growing Market

As the popularity of new-vehicle leasing increases, so has the number of used late-model cars and trucks on dealer lots everywhere. In response, the leasing industry has opened the door to broad-based used-car leasing. Used-car leasing began with independent leasing companies and moved into the mainstream with a handful of manufacturer-driven used-car lease programs on luxury cars and sport utility vehicles. Now, used-car leasing has grown into a substantial business, attracting most of the major auto manufacturers and a sizable cadre of conventional lenders. As new-car leasing grows, used-car leasing will gain in popularity, not only in the luxury and sport utility markets, but also among mid-priced vehicles as well.

Adding to this popularity are programs such as Volvo Certified Pre-Owned Car Program, which offers reconditioned two- to four-year-old Volvos, with under 60,000 miles, which undergo painstakingly thorough inspections and reconditioning. The vehicle then comes with a 24 month/24,000 mile Volvo Certified Limited Warranty with zero deductible; affordable financing options both loan and lease; two seventy-five dollar vouchers for service at a Volvo retailer; 24-hour On-Call Roadside Assistance; and the Tire Protection Plan.

According to CNW Marketing/Research of Bandon, Oregon, an excellent resource for lease marketing data, more than 500,000 used vehicles were leased in 1997. That's more than 9% of all leases and nearly 3% of all used-vehicle acquisitions! The primary growth impetus will be consumer awareness. According to a 1997 CNW survey, nearly 72% of those questioned knew leases were available on new vehicles. Amazingly, only 14% were aware that they could lease a used vehicle. As that figure increases, so will the popularity of used-vehicle leases.

The Difference Between A New And Used Car Lease

The two main differences between new- and used-car leases are the money factor and the rate of depreciation the vehicle will experience over the course of the lease. On one hand, a gently-used vehicle (2 years old) depreciates less during the next two or three years than it did during its initial two years. That saves money because the amount you commit to repay under your lease (the depreciation) is less. On the other hand, the money factor or average rent charged on a used lease is almost always higher than on the same car when it was new. That costs money in the form of higher interest. Let's take a closer look at both factors.

The Residual Value Factor

A vehicle's residual value is the amount it is predicted to be worth at the end of the lease. Residual values are typically expressed as a percentage of MSRP (sticker price). In general, cars that perform well and have low cost of repair and high perceived value tend to hold their value well. If the market likes a vehicle (i.e. Toyota Avalon, Ford Explorer, Lincoln Navigator, Honda CR-V), it will have a higher than average residual value. Those vehicles with lower perceived values (Chevy Metro, Hyundai Accent, Dodge Neon, Mitsubishi Mirage) tend to have low residual values. A vehicle's perceived value is made up of a number of factors, including actual performance, customer satisfaction, market supply, demand for that supply and warranty life. Residual value charts are available on CarWizard.comat http://www.carwizard.com.

In the first two years of an average car lease, the vehicle will usually depreciate by more than 38%! Over the next two years, the vehicle will likely decline by less than 20%. After the vehicle is four to five years old, the depreciation begins to accelerate again for most makes and models. The reasons for the difference in depreciation rates vary. If the car is leased new for only two years, the next driver has the opportunity to lease it and experience nearly 50% less depreciation than her predecessor. If the car is in good condition and the body design has not changed radically, this has the makings of a good deal! Remember, the smaller the depreciation, the lower the monthly payment (all other things being equal).

In an effort to move more new cars into the market and betting on the lessee to either terminate early or purchase the leased vehicle, new-car lessors have offered artificially high residual values to drive down monthly payments and make their products more affordable. The same game cannot be played once a vehicle enters the used-vehicle market. To the consumer, this means more realistic residual values and thus higher monthly payments. If a lessor inflates the residual value of a used car it will probably come back to haunt her when the car comes back as an off-lease vehicle worth less than the predicted residual value. The lessor loses money because the lease was structured to repay only a certain amount of depreciation (cap cost less residual). If the residual value is too high, the lessor will not receive enough from the payments to cover the actual depreciation that occurred while the used car was on lease.

The Money Factor

What is saved by less severe depreciation on a used vehicle lease is, in many cases, swallowed up by a higher Money Factor. Money Factors are used to calculate the average monthly "rent charge" -- akin to monthly interest in a vehicle loan -- collected on a lease. The higher Money Factor for used vehicles indicates the increased level of risk for the lessor. Since it is more difficult to predict the selling price of a used car coming off a two-year lease than it is for a new car leased for an equal term, lessors hedge against this by increasing the money factor. The lessor must plan for the return of the vehicle and further hedge against an unexpected decline in the market value of the vehicle with a higher rate than for a new vehicle lease or a used-car loan.

Is Used Car Leasing A Good Deal?

The answer is, it depends! During the relatively brief history of used vehicle leasing, there have been many instances where the monthly cost of a used-car lease is only a few dollars less than leasing the same model new. This occurs when a captive finance company calculates the payments based on an extremely high residual value and a low lease rate on the new model. Make the comparison. If this occurs -- lease the new car. For most people, saving $10 - $30 per month in payments is not enough to discourage leasing a brand new car.

In many cases, used-vehicle leases offer the same advantages as those for new-car leases over purchases. When you cannot afford to buy a gently-used Lexus, it may be possible to lease it with virtually the same styling and warranties as with the new model. Moreover, the lease payment will likely be smaller than the payment to purchase the used vehicle.

Shopping Tips For Used Vehicle Leases

1. Find out the cost of leasing the same model new! Use it for comparison purposes. It could provide a pleasant surprise.

2. Find a vehicle that has been owned or leased for no more than 36 months. You are not buying the car and the length of prior ownership determines how fast the value of the vehicle declines while you are leasing it -- the residual value. A vehicle previously used for 24 months is usually the best bet.

3. Check the mileage on the car. If it exceeds 15,000 per year, the predicted residual value at the end of the term will be lower, yielding a higher monthly payment.

4. Make sure the vehicle has a manufacturer's certification. This is different from a dealer's certification, which is usually only good for getting specific work performed at that dealership. A manufacturer's certification generally permits service work to be done by any same-make dealer. When considering vehicles of different makes, be sure to compare warranties. Most of the major automakers now have certification programs.

5. Check the warranty! If there is still time left on the original manufacturer's warranty, it transfers to the next owner. See if the dealer or lessor has an extended warranty available and whether it is included in the price. It is important to purchase an extended warranty that picks up when the manufacturer's warranty ends, not one that cancels it out. By law, this information should be disclosed to you and listed on the window sticker as full or limited, express or implied.

• Full Warranty: Provided to anyone owning the vehicle during the warranty period. Service must be provided free-of-charge when necessary. Services should include removing or reinstalling a covered system or part. It also allows the consumer to choose either a replacement or a refund if the vehicle can't be repaired after a reasonable number of attempts. Under a full warranty, the consumer is not required to take any action to receive service, except to give notice that service is needed.

• Limited Warranty: Any warranty that is less than a full warranty.

• Implied Warranty: The dealer does not make any specific promises to fix things that need repair. However, state law "implied warranties" may give the consumer the right to require the dealer to repair serious defects not apparent at purchase time. There can be no limit on the length of any implied warranties under state law.

• As Is -- No Warranty: The dealer assumes no responsibility for repair. But is required to disclose any known defects.

For more information this subject, read "Used Car Warranties: To Buy or Not to Buy

6. Shop the residual values. Purchase Automotive Lease Guide's used residual value guide or visit Car Wizard at http://www.carwizard.com. Look up the vehicle using its model year and find its value at the end of the lease term. Subtract that value from the capitalized cost charged by the lessor to determine the depreciation to be financed.

7. Shop the rates. Compare the rates of one leasing company to another for the same vehicle. As used-car leasing increases in popularity, so will the number of independent lessors, manufacturers and lending institutions competing for business.

8. Do the calculations as you would for a new lease. Make sure the lease agreement has the same protections as it would for a new car. Again, check out programs such as Volvo Certified Pre-Owned Car Program for favorable leasing agreements.

9. Keep the term less than 36 months! Make the term shorter if the car is more than two years old when you lease it. Because the value of the car declines at an increasing rate beginning around the fifth year, the benefits of a used-car lease erode if the term extends into that period. Keep the lease equal to or shorter than the duration of the warranties.