Driving home in a new set of wheels is a rewarding feeling, but long after that new car smell fades, you'll likely be on the hook for monthly car payments.
For most buyers, financing with a traditional auto loan makes the most sense. But did you know you can also buy a car with a personal loan? Using a personal loan can be especially useful when buying a car that doesn't qualify for traditional financing or if you're buying from a private party.
Below, we'll explore how traditional secured auto loans and personal loans each work for vehicle financing to help you determine which is best.
How personal loans work
You can use a personal loan for almost anything, including purchasing a car. Rates and monthly payments are typically fixed, and repayment terms typically last from a few years to seven years. Since most personal loans are unsecured, rates tend to be higher compared to traditional auto-secured loans. However, for this same reason, there are fewer (if any) restrictions on the type of car you can purchase.
Tip
Older model year cars, high-mileage cars, salvage cars, antique or classic cars, and rare cars that are hard to insure can all be financed with a personal loan.
Here's how personal loans work when buying a vehicle:
- Figure out what car you want to buy: Treat this like the traditional car-buying process. Do your research, take some test drives, and narrow down your list of options to one specific vehicle, new or used, and figure out the overall amount you need to borrow (don't forget things like taxes and fees).
- Apply for a personal loan: Follow the typical steps to get a personal loan, including comparing lenders, getting prequalified, and applying online. Once approved, you should have funds within a few days. (Prioritize personal loans with same-day funding if you're worried another buyer may swoop in and purchase the car.)
- Purchase the car: With a personal loan, the money is in your pocket, so buying from a dealership or private party is seamless.
- Repay your loan: Most personal loans are unsecured, meaning the car doesn't serve as collateral. While you generally can't lose the car from missing payments, missed payments can result in expensive late fees, damage to your credit score, and legal action if you don't get caught up.
Pros and cons of personal loans for buying a car
Pros
- No down payment required
- Typically no collateral (i.e., no risk of your car being repossessed)
- No full-coverage auto insurance required
- A car appraisal is not required
Cons
- May require good or better credit
- Typically higher interest rates than car loans
- Not eligible for special financing terms or incentives
How auto loans work
An auto-secured loan is also a type of installment loan, except that it's secured by the vehicle you purchase:
- You borrow the money needed to pay for a car.
- The car acts as collateral for the loan.
- You make monthly payments (including interest) until you've paid off the car.
- A down payment is often required.
You can obtain the auto loan in one of two ways:
- Indirect lenders: If you show up to a car dealership without financing secured, the dealer's finance department can work with its network of lenders to find a loan for you.
- Direct lenders: You can proactively secure financing through a bank, credit union, or online lender. This method lets you compare rates before showing up at the dealership.
Pros and cons of auto loans
Pros
- May be available to borrowers with poor credit
- Lower interest rates than personal loans
- Some new cars eligible for auto loan interest tax deduction
- May offer special financing terms (e.g., 0% APR)
Cons
- Risk of repossession for missed payments
- Full-coverage auto insurance required
- Down payment required
- Typically unavailable for older, high-mileage models or salvage cars
Important
The auto loan interest tax deduction defines an eligible vehicle as “a car, minivan, van, SUV, pick-up truck or motorcycle, with a gross vehicle weight rating of less than 14,000 pounds, and that has undergone final assembly in the United States.”
Auto loans vs. personal loans: Similarities and differences
While auto loans and personal loans share some similarities, there are major differences to consider — most notably, interest rates. Down payment, credit score, and vehicle requirements are other factors to weigh.
Impact on credit
Both personal loans and auto loans can have positive and negative impacts on your credit. Neither one stands out as being more or less positive or negative.
- Hard inquiry: Applying for either type of loan will typically result in a hard inquiry on your credit report, which could lower your score by up to 10 points. While the inquiry remains on your credit report for two years, it only influences your credit score for one year.
- Payment history: Payment history accounts for more than a third of your overall FICO score (35%). Making your personal loan or auto loan payments on time could improve your credit score over time; however, missing a payment could bring your score down.
APR ranges
In general, annual percentage rate (APR) ranges for secured auto loans are lower than they are for personal loans. APR represents the annualized cost of borrowing, accounting for both the interest rate and upfront lender fees such as origination fees.
- Auto loans: Interest rates from 5% to 16% for new cars and from 7% to 22% for used cars.
- Personal loans: Personal loan rates are typically capped at 36%. However, average rates range from 10% to 16% for borrowers with excellent credit and 29% to 32% for borrowers with fair credit.
For both personal loans and auto loans, the APR depends on several factors, including your credit score and the repayment term you choose (longer terms generally have higher rates). There can also be variance in rates for:
- Traditional secured auto loans: The type of car affects the rate for traditional auto loans — interest rates for new cars are lower than rates for used cars.
- Personal loans: Most personal loans are unsecured (no collateral); however, you may be eligible for a lower rate by getting a secured personal loan.
Collateral
A traditional auto loan uses the car you're financing as the collateral on the loan. If you default on payments, the lender can repossess the vehicle to recoup its investment.
Personal loans do not usually require collateral, which makes them less risky for the borrower. If you fall behind on your loan payments, the lender cannot repossess your vehicle. However, there are plenty of other risks of defaulting on your loan, such as damage to your credit score and legal action.
Note
Borrowers with bad credit may be able to qualify only for a secured personal loan. These loans do require collateral.
Time to fund
How long it takes to fund an auto loan or personal loan depends on the specific lender. However, both auto and personal loan funding speeds can be as quick as the same or next business day. It's possible, for example, to walk into a dealership, test drive a car, secure financing through the dealer's lender network, and drive home in the car that same day.
Some lenders may take a few business days, however. Compare approval and funding speeds when researching lenders.
Down payment
Often, auto loans require a down payment, much like a mortgage. Down payments may range between 10% and 20%, though many experts recommend putting at least 20% down, regardless of lender requirements. The larger your down payment, the lower your monthly payment. Plus, a larger down payment could yield a lower interest rate.
Tip
Some lenders of secured auto loans may offer special financing terms, such as “zero down.”
Personal loans don't have down payments. However, many personal loans have origination fees, expressed as a percentage of the total loan amount. This amount is typically deducted upfront from the loan proceeds. For instance, a 5% origination fee on a $20,000 personal loan would be $1,000. In this instance, you'd receive $19,000, but you'd have to repay the full $20K back, plus interest.
If the only appeal of a personal loan over an auto loan is the lack of a down payment, you might want to reconsider. Though it's nice not to have to drain your savings for a down payment, the higher interest rate of a personal loan means you could spend significantly more on a new car in the long run.
Expert take: “It might make more sense to use public transportation and build up savings to put cash down on the car and improve your financial situation. Getting into these arrangements [higher-interest personal loans] does not typically help long-term finances for people; it just keeps the debt cycle going.”
— Chad Gammon, certified financial planner and owner of Custom Fit Financial
Repayment terms
Auto loan and personal loan repayment term lengths vary by lender. However, both types of loans usually have repayment terms ranging between two and seven years. You'll need to compare specific lenders more closely to know what repayment options are available.
In general, choosing a shorter loan term can lower your interest rate and reduce the total interest you pay, but it does also increase your monthly payment amount.
Minimum credit score requirements
There's no single minimum credit score requirement for personal loans, but many lenders set the bar at 640 or higher. Some lenders offer personal loans for bad credit, but they generally have higher interest rates and fees and smaller loan amounts — plus, they're still difficult to qualify for. Getting a secured personal loan or a joint personal loan can help your chances if you have bad credit.
There's also no universal credit score requirement for auto loans. Even borrowers with fair or worse credit can typically secure financing for a vehicle, although loan limits may be smaller and interest rates may be higher.
Borrowers with poor credit may be tempted by used car dealerships advertising “buy here, pay here” or “no credit check auto loans.” These dealers offer their own financing (rather than through a network of legitimate lenders), and they only consider your income, instead of your credit score.
“That might sound appealing, but they usually charge very high interest rates,” warns R.J. Weiss, certified financial planner and founder of The Ways to Wealth. Plus, some dealers market their services as a way to build your credit, but only report negative information to the credit bureaus, according to the Consumer Financial Protection Bureau. “[Buy here, pay here] is a last resort for someone who urgently needs transportation,” Weiss adds.
Loan amounts
Personal loan amounts vary by lender and borrower. It's possible to qualify for a small personal loan for as little as $1,000 or $2,000, while some lenders offer loans as high as $100,000.
More often than not, however, personal loans max out at $50,000. Traditional auto loans may be available for over $100,000.
Model years
It's easy to secure a car loan for a brand-new vehicle purchased through a dealership, but you may have trouble buying an older car from a private seller with traditional financing. According to Kelley Blue Book, some lenders are willing to offer financing for vehicles that are 10 to 15 years old. Anything older may be hard to finance with an auto loan.
Because there are very few things you can't buy with a personal loan, you likely won't have trouble purchasing a super-old vehicle with a personal loan.
Car condition
Similarly, traditional auto financing may have strict vehicle requirements related to condition. For instance, lenders may not offer financing on high-mileage used cars. Lenders may also opt out of financing vehicles with a salvage title.
Again, personal loans are much more flexible. A personal loan may be the better financing route if you're purchasing an older, high-mileage model or a car with issues.
Real-world examples of auto loans vs. personal loans
While there may be scenarios where a personal loan makes sense (we'll explore those below), it's important to remember that an auto loan is almost always the more affordable way to finance a vehicle purchase — if it's available for the car you want.
The tables below show three examples of using an auto loan vs. a personal loan to buy a car. You can use an auto loan calculator and a personal loan calculator to do more simulations.
$20,000 car
Imagine you're buying a $20,000 car. You can get an auto loan with a $2,000 down payment and a 7% APR, or a personal loan with no down payment and a 12% APR. The term for each loan is 5 years.
$30,000 car
Imagine you're buying a $30,000 car. You can get an auto loan with a $3,000 down payment and a 10% APR, or a personal loan with a 14% APR. The term for each loan is 6 years.
$40,000 car
Imagine you're buying a $40,000 car. You can get an auto loan with a $4,000 down payment and a 15% APR, or a personal loan with a 20% APR. The term for each loan is 4 years.
Examples of when each option is a better choice
Below, we'll explore when buying a car with a personal loan makes sense and when it's a better idea to go with more traditional financing.
Scenarios when personal loans make more sense
There are a few scenarios in which using a personal loan to buy a car makes sense, such as:
- No down payment saved up: If you don't have the cash for a down payment and need a car now, consider a personal loan (or a zero-money-down new car loan, if you qualify).
- Older or high-mileage vehicle: Some auto lenders won't approve a loan for an older car with a lot of miles or in poor condition. Personal loans don't have the same restrictions.
- Old car restoration: If you're fixing up a classic car, you may need more money than just the list price. Taking out a personal loan for more than the price of the car could give you the funds you need to make repairs and upgrades.
- Car insurance considerations: Auto loans usually require you to carry full-coverage auto insurance. If you don't have the budget for collision and comprehensive or would rather self-insure, consider a personal loan instead.
- Concerns about repossession: If the thought of having your vehicle repossessed because of a missed payment makes you nervous, consider a personal loan. Just keep in mind that defaulting on a personal loan has major consequences, too.
Editor insight: “Restoring a classic car could take anywhere from a few hundred dollars to tens of thousands of dollars, depending on the car, its condition, how fully you want to restore it, and whether you do the work yourself or turn to a professional. For example, you might have to pay a premium for hard-to-find replacement parts if you're dealing with a particularly old model. If the project involves extensive work on the chassis, engine, or transmission in a custom restoration shop, labor costs could accelerate faster than a 1965 Shelby Cobra.”
— Barry Bridges, Personal Loans Editor, Credible
Scenarios when car loans make more sense
While there are highly specific scenarios in which personal loans make sense for buying a car, you'll find that more often than not, using an auto loan to finance a car is the better move.
Here are some signs a car loan is the right move:
- You can afford a down payment.
- You're buying a new vehicle or a vehicle made within the last decade.
- You're buying a car from a dealership.
- You want to keep monthly payments low.
Alternative funding options to consider
Car loans and personal loans aren't your only options when you're ready to upgrade to a new daily driver. Here are some alternative funding options to consider:
Paying cash
If you want to avoid paying interest on a loan and don't want to have to worry about a lender's model-year, mileage, or insurance requirements, you could always pay cash for your next set of wheels.
You might not be able to pay out of pocket for a new, fully loaded, top-trim luxury pickup truck, but there are plenty of used cars under $20,000, $10,000, or even $5,000, through dealers, used car retailers like CarMax and Carvana, and private sellers.
If you have the cash on hand — and have a vehicle to trade in to help lower the price — you can save a lot of money long term by paying out of pocket.
Leasing
If you find yourself regularly upgrading to a new car, it may make more sense to lease instead of buy. When you lease, you don't actually take out a loan; instead, you pay a monthly payment to “borrow” the car, with a few restrictions (like mileage caps).
At the end of the lease (often two to three years), you have to turn the car back over to the dealer, and you can choose to lease another (new) vehicle or purchase a car this time around. You won't make any money when you turn the car in, and you'll never escape a monthly car payment if you perpetually lease. But if you regularly purchase new vehicles anyway, leasing could make a lot of sense.
Home equity loans or HELOCs
Much like personal loans, you can use a home equity loan or home equity line of credit (HELOC) for almost anything, assuming you have the credit score and home equity to qualify. Interest rates for home equity loans and HELOCs are lower than they are for personal loans, but your house itself serves as collateral.
FAQ
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