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If I want to refinance a car that is two years old, and getting a new car loan is better APR then a used car loan and even a refinanced loan, why does it matter which way you go? Isn't a loan just a loan? You get money and you pay it back over time so wouldn't only the APR matter?

I'm just confused as to why there are so many different types of loans all with different APR rates when in the end aren't they all the same?

In summary: what keeps me from just getting a loan with the best rate and taking that money to pay off my current loan and then just pay the lowest loan/new loan?

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New car loans, used car loans, and refinances have different rates because they have different risks associated with them, different levels of ability to recoup losses if there is a default, and different customer profiles. (I'm assuming third party lender for all of these questions, not financing the dealer arranges, as that has other considerations built into it.)

A new car loan is both safer to some extent (as the car is a "known" risk, having no risk of damage/etc. prior to purchase), but also harder to recoup losses (because new cars immediately devalue significantly, while used cars keep more of their value). Thus the APRs are a little different; in general for the same amount a new car will be a bit lower APR, but of course used car loans are typically lower amounts.

Refinance is also different; customer profile wise, the customer who is refinancing in these times is likely someone who is a higher risk (as why are they asking for a loan when they're mostly paid off their car?). Otherwise it's fairly similar to a used car, though probably a bit newer than the average used car.

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    Good answer, however I would argue that for new cars, the cost of financing is baked into the sales price, and you could negotiate a lower sales price if you don't finance the car. The default risk is actually higher for a new car for the reason you gave (massive drop in value)
    – D Stanley
    Commented Sep 22, 2017 at 15:54
  • @DStanley I'm assuming third party lender, here, I'll make that clear. I'm separating "risk" from "difficulty to recoup value"; the risk of a used car is that it's unclear how good of a condition the car is in, while the risk of a new car there is lower.
    – Joe
    Commented Sep 22, 2017 at 15:55
  • @Joe: Another way of expressing that latter risk is to say that a lender can generally trust that the value of a new car purchased for $20,000 will be similar to other cars of the same make and model. By contrast, even if the blue-book value of a used car would be $5,000, the actual might be less than $1,000 if it has been badly abused. Without inspecting a car, a lender who provides $3,000 toward the purchase would incur the risk the engine might blow up two days later as a consequence of earlier abuse, resulting from the buyer walking away from a vehicle that's basically worth scrap.
    – supercat
    Commented Sep 22, 2017 at 17:53
  • @Joe: I'd argue that the risk to the lender doesn't much depend on the car, as they're unlikely to recoup anything like the full loan amount if they have to repossess it. Repossession seems more like the loan shark kneecapping the occasional defaulting borrower: a cost to provide an object lesson to the others :-)
    – jamesqf
    Commented Sep 22, 2017 at 18:00
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    @jamesqf I'm quite confident the amount likely recouped, and the risk around that amount, factors significantly into lenders' calculations of required interest rates.
    – Joe
    Commented Sep 22, 2017 at 19:06
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According to AutoTrader, there are many different reasons, but here are three:

  1. Resale value
  2. Lenders Want You to Buy New Cars
  3. Credit Scores

New cars have a better resale value and it's easier to predict its resale value in case you default on the loan and they repossess the car. Lenders that are through auto makers can use different incentives for getting you to buy a new car. Used car financing is usually through other banks. People with higher credit scores tend to buy new cars, and therefore can get a lower rate because of their higher credit score.

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There are normally three key factors that define different kinds of loans, these factors affect the risk that the lender takes on and so the interest rate. The interest rate on any loan is linked to market interest rates; the lender shouldn't be able to receive a higher rate of interest for lending the money at no risk, and the level of risk that the lender believes the borrower to have.

The three features of a particular loan are:

  • whether the loan amortises or not
  • whether the loan is secured or not
  • whether the borrower has a guarantor on the loan

These reduce the risk of complete or total non-payment (default) of the principal or any missed interest payments. Taken in order:

Amortising Here some of the monthly payment pays a proportion of the underlying principal of the loan. This reduces the amount outstanding and so reduces the capacity for default on the full principal as part of the principal has already been paid.

Security In a secured loan there is an asset such as a car, house, boat, gold, shares etc. that has a value on resale that is held against the loan. The lender may repossess the security if the borrower defaults and recover their money that way. This also acts as a "stick" using the loss of property to convince the borrower that it is better to keep paying the interest. The future value of the security will be taken into account when deciding how much this reduces the interest rate.

Guarantor A guarantor to a loan guarantees that the borrower will repay the loan and interest in full and, if the borrower does not fulfil that obligation, the lender is able to seek legal redress from the guarantor for the borrower's debts.

Each of these reduce the risk of the loan as detailed and so reduce the interest rate.

The interest rate, then, is made up of three parts; the market interest rate (m) plus the interest rate premium for the borrower's own credit worthiness (c) minus the value of the features of the loan that help to reduce risk (l). The interest rate of the loan (r) is categorised as: r = m + c - l.

Credit ratings themselves are an inexact science and even when two lenders are looking at the same credit score for the same person they will give a different interest rate premium. This is mostly for business reasons, and the shape of their loan book, that are too tedious to go through here.

All in all the different types of loan give flexibility at the cost of a different interest rate. If you don't want the chance of your car being repossessed you don't take a secured loan, if you have a family member who can help and doesn't mind taking on your risk take a guaranteed loan.

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  • All accurate, but it seems like it doesn't answer the question (which is asking about automobile loans).
    – Joe
    Commented Sep 22, 2017 at 16:07
  • I was answering the more general question -OP starts asking about car loans and then gets more general so I've given the higher-level answer.
    – MD-Tech
    Commented Sep 22, 2017 at 16:09
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    I understand that, but I think you give a not very well fit answer to the question as a result. You've not really stayed at a higher level - you're quite detailed, probably too much so for the question, and yet didn't actually answer the question.
    – Joe
    Commented Sep 22, 2017 at 16:21
  • you think it needs the "Noddy" approach of replacing "security" with "car" throughout?
    – MD-Tech
    Commented Sep 22, 2017 at 16:24

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