While it is possible to use a personal loan to buy a car, it is probably not your best financing option. An auto loan typically offers lower interest rates, so it could cost you less than a personal loan.
But there are some circumstances where a personal loan might make sense; For example, if you are purchasing a car that is too old or has too many miles to qualify for a traditional car loan. Here’s a closer look at personal loans vs. auto loans so you can choose the best strategy for your next vehicle.
Personal loans are a type of installment loan that you can use for almost any purpose, including purchasing a car. They come with fixed interest rates and repayment terms typically range from five to seven years.
Most personal loans are unsecured, so there is no need to provide collateral. Instead, the lender evaluates your financial profile, including your credit and income, when you apply.
If you fall behind on payments, the lender cannot repossess your car. However, there may be other consequences, including late payment fees, collection activities, damage to your credit score, and even legal action.
The plus side is that many lenders offer fast financing for personal loans. You may receive your funds the same day or the next day after approval.
Auto loans are designed for purchasing a car and can be a more affordable option than a personal loan. They are a type of secured loan that uses the car as collateral. Your car loan will specify which vehicle you will use to purchase and will include the vehicle identification number (VIN) on your loan documents.
Because auto loans are secured, they may have less strict eligibility requirements than personal loans and have better interest rates. Even a small reduction in your interest rate could save you hundreds or thousands of dollars over the life of your loan.
The downside to a secured car loan is that the lender can repossess your car if you fall behind on payments. You may also need to make an upfront down payment on the car, while no down payment is required for a personal loan.
Auto loan interest rates are typically fixed and repayment terms can span up to seven years. Your interest rates and approval chances depend not only on your credit score and income, but also on the type of vehicle you’re purchasing, including whether it’s new or used.
Read more: How to buy a car without collateral: a guide for first-time buyers
Below is a closer look at the key differences between personal loans and auto loans.
While you can use a personal loan to buy a car, it can be more expensive than an auto loan. Here’s why a personal loan may not be ideal for your car purchase:
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You may have a higher interest rate: While the average rate on a two-year personal loan is 11.14%, according to the Federal Reserve, interest rates can be as high as 36%. On the other hand, the average auto loan rate is 7.64% on a five-year auto loan. Choosing a loan with the lowest interest rate will mean more affordable monthly payments and lower borrowing costs.
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It could come with a shorter payback period: With some lenders, the maximum repayment period for a personal loan is limited to five years. Many auto loans span up to seven years, allowing you to spread out payments and have lower monthly bills.
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Loan amounts may be limited: Lenders determine your personal loan amount based on several factors, including your credit score, your income, and the purpose of the loan. It is not guaranteed that you will qualify for the full amount you need to purchase your car.
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Borrowing requirements may be stricter: Since most personal loans are unsecured, lenders may have stricter credit, income, and debt-to-income ratio requirements than you’ll find with auto loans. Without good credit (or a creditworthy cosigner), you may have trouble getting approved or get stuck with a high interest rate and origination fee.
Although it’s less common to use a personal loan to buy a car, there are some scenarios where it might make sense:
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You may not qualify for a conventional car loan: A traditional auto loan is not available in all cases. For example, some lenders don’t offer financing for cars that are more than a decade old or have more than 100,000 miles. They may also not offer a loan if the cost of the car you are buying is too low. Additionally, you can’t get financing from a dealer if you buy from a private seller (although you can seek an auto loan directly from a lender).
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You have high risk credit: Bad credit can make it difficult to qualify for a traditional auto loan. You can explore second chance auto loans, but keep in mind that they usually have high rates and fees. Some personal loan providers will work with borrowers with bad credit, although you will still be subject to higher rates and fees. In this situation, compare your subprime auto and personal loan options to see which offers the best deal.
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You do not want to make a down payment: Some auto loans require you to make a down payment up front, while you don’t need one with a personal loan. However, the risk of not making a down payment is that you could end up defaulting on your loan, meaning you owe more than the car is worth.
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You can get a better deal with a personal loan: A personal loan could be a smart choice if you can get a good interest rate. Rates start in the single digits for borrowers with excellent credit, and some lenders don’t charge upfront fees. It may be worth shopping around to see which type of loan – a personal loan or a car loan – offers the lowest borrowing costs.
Personal loans offer flexibility and quick financing, but often come with higher interest rates and shorter repayment terms compared to auto loans. While you can use a personal loan to buy a car, it is probably not the most cost-effective option.
Regardless of the type of loan you choose, it’s worth comparing prices and options from several lenders. By verifying your rates through prequalification, you will be able to review offers and find the best deal. Compare interest rates, repayment terms, loan amounts and fees to find the most affordable loan.
This article was edited by Alicia Hahn.