If you’re shopping for a new car, you may be in for some sticker shock. The average MSRP of a new car is now almost $45,000, and the average used car price has hit $33,000.[1, 2]
Those sorts of prices can seriously limit your payment options. Is a personal loan one of those options?
Usually, it makes more sense to finance your purchase with an auto loan, but there may be circumstances where a personal loan can make sense. Here’s a breakdown of how personal loans and auto loans compare.
What Can Personal Loans Be Used For?
A personal loan (sometimes called a “personal installment loan”) is a loan arrangement in which you borrow money from a bank or lender in a lump sum, then repay it through monthly installments.
Interest rates vary, but the main advantage of personal loans is that they can be used for various purposes, from debt consolidation to home improvement, educational expenses, and more. A personal loan is not tied to any specific purpose.
Can You Use a Personal Loan to Buy a Car?
It’s possible to use a personal loan to buy a car. As a general rule, lenders care more about your ability to repay the loan than what you plan to spend the money on. Your lender may ask about the purpose of your loan, but this won’t affect your eligibility.
However, that doesn’t necessarily mean using a personal loan to buy a car is a good idea. It’s important to compare rates and terms to choose the type of financing that’s right for you.
Auto Loan vs. Personal Loan
Should you use a personal loan or an auto loan to purchase a car? It depends.
Generally speaking, you’ll have an easier time qualifying for an auto loan and will likely pay less interest and lower fees. Here’s a comparison of the features of each loan type so you can see which one comes out ahead.
Type Of Loan
Auto loans are secured loans. If you don’t pay, the lender can repossess the vehicle and sell it to recover their costs.
Most personal loans are unsecured. If you don’t pay, the lender has little recourse beyond selling the account to a collection agency, usually at a large loss. This makes unsecured loans riskier for lenders.
Because of that lower risk, secured loans usually have easier approval standards and lower interest rates.
Purpose of the Loan
While personal loans can be used for many different purposes, auto loans are very specific. You can only use an auto loan to purchase a car, and some loans may be designed exclusively for buying new vehicles.
A personal loan gives you more flexibility. If you’re also trying to complete a home improvement project, you can use the same personal loan for your home and car. Even so, you’ll likely discover that you get better interest rates by opting for an auto loan.
Credit Score Requirements
Because auto loans are secured, credit score requirements are typically relaxed. It is possible to get an auto loan even with fair or poor credit, but you will pay a very high interest rate that will significantly increase the cost of your vehicle.
Personal loans typically require higher credit scores. If your credit is not great, the interest will rise steeply, and you may not be approved at all.
It’s possible to obtain a secured personal loan, which offers lower credit eligibility standards. But then you’ll need to offer collateral, such as another vehicle or even your house. That can be a tall order if you need a loan to purchase a vehicle.
Interest rates can vary between lenders, but auto loans generally offer better rates than personal loans, especially if you have strong credit.
According to Forbes, the average personal loan interest rate is 10%, though it can range from 4% to 36%. However, Experian reports that the average auto interest rate is 5.16% for new cars and 9.34% for used cars.
Furthermore, many dealerships have introductory incentives that offer even greater savings on new or certified pre-owned vehicles. When you combine all these factors, you may be able to purchase a car with an extremely low APR, especially if you have good credit.
Down Payment Requirements
Depending on your credit history, you may or may not be able to take out an auto loan for the entire cost of your vehicle. Some dealers may ask you to submit a down payment before allowing you to finance the remainder of your vehicle. This is most common if you have poor credit.
Personal loans do not require a down payment. An unsecured personal loan can be obtained with no collateral whatsoever, meaning you won’t need any resources upfront to obtain your loan.
Can I Use a Personal Loan as a Down Payment for a Car?
While some dealers will allow you to finance the entire cost of a new or used vehicle, others require you to make a down payment and cover the rest with an auto loan.
The amount of your down payment can depend on your credit history. If you have low or poor credit, you may be asked to submit a larger down payment and use an auto loan to pay the remainder.
But what if you don’t have enough money to cover a down payment? This is where a personal loan can be beneficial. You may be able to use a personal loan to cover the down payment, then use an auto loan to pay the balance.
In other words, you’d use two loans to purchase the same vehicle. Your personal loan would go toward the down payment, while the auto loan lets you tap into the low interest rates of a car loan.
The drawback is that if you have low credit, you could pay steep interest rates on the loan you use to make your down payment. You’d also be responsible for two monthly loan payments, which raises the probability of missed payments that could further lower your credit.
✍️ Note: Many auto lenders will not allow you to use a loan to cover your down payment. They have access to your credit report, so they will know!
Should I Use a Personal Loan or Auto Loan for Used Cars?
When you buy a car from a dealership, you’ll usually have access to affordable car loan interest rates. You can choose between dealer financing and independent lenders, and that choice will give you a better chance of a good deal. But what if you buy a used car in a private sale?
For instance, if you buy a car from a social media marketplace, you won’t be able to tap into the kinds of car loans you get from a dealership. If the car is old or needs work, you may not find an auto lender to finance the purchase. In these instances, using personal loans for used cars may be an option.
If you purchase a used car, you’d need to compare rates to determine which financing option is better for you. Usually, you’ll receive better rates through a car loan, though if you have low credit, you might consider a personal loan as an alternative.
Should I Take a Personal Loan Out to Buy a Car?
Can you use a personal loan to buy a car? Yes, but a personal loan is rarely a better choice than an auto loan.
Still, there may be situations where it makes sense to take out a personal loan to buy a vehicle. Here are some examples of appropriate circumstances for buying a car with a personal loan.
1. Your Personal Loan Interest Rates Are Lower
While not likely, your personal loan interest rate could be lower than a car loan.
As noted above, some personal loans are available with interest rates as low as 4%. It’s possible that this rate could fall below the interest rate of a car loan, especially when buying a used vehicle.
2. You’re Purchasing a Car from a Private Seller
By purchasing a car or truck from a private seller, you eliminate the middleman of the dealership. You’ll still need to verify that the car is in good working order, but otherwise, you can save money by buying a car through a private sale.
But that also means you’ll need cash in hand to complete the purchase. There are auto lenders that will finance private-party transactions, but there may be restrictions on the type, age, and condition of the vehicle.
If you’re buying a vehicle that does not meet these conditions, a personal loan could be an option.
3. You’re Buying a Car That Needs Extensive Work
You might be able to save money by buying an older car that needs work to be truly road-worthy. But banks and credit unions aren’t always eager to provide auto loans for cars that need extensive restoration since this represents a significant risk.
Instead, you can use a personal loan to cover the cost of the vehicle and any subsequent repairs. Your interest rates will be higher, but you’ll have the flexibility to use the loan for the initial purchase and any future maintenance or upgrades you perform on the vehicle.
If you’re buying a project car, a personal loan might be a good option, especially if your credit is solid and you qualify for a good interest rate.
4. You Want to Avoid Full Coverage Insurance
Every state has minimum insurance requirements. But when you finance a car or truck, you’re usually expected to purchase a full coverage policy, which combines comprehensive, collision, and liability insurance. The lender wants to be sure that if the car is stolen or destroyed, and the insurance payoff will cover the loan.
Car and Driver report that the average annual rate for full coverage insurance is $1,758. The average annual rate for a state’s minimum insurance requirements is only $588. Again, this minimum insurance depends on your state but usually involves some basic combination of bodily injury or property damage insurance.
Using a personal loan to buy a vehicle lets you adhere to your state’s minimum insurance guidelines and avoid paying a high rate for full coverage insurance. Just make sure you think through the impact of a higher interest rate, as a higher loan payment could easily cancel out the savings of a minimum insurance policy.
When to Use an Auto Loan to Buy a Car
While a personal loan can be used to buy a car, auto loans are likely your best option. Here are the main reasons why.
1. Interest Rates Are Lower
Car loans usually offer lower interest rates than personal loans. Even a difference of a single percentage point can save you thousands of dollars over the loan’s lifespan. And you can save even more if you take advantage of promotional rates.
2. Term Periods Are Longer
The average car loan comes with a long term, allowing you to spread out your monthly payments over the course of the loan.
Smaller monthly payments can fit more easily into your budget and may also increase your spending power. Personal loans often have shorter terms, which translate into higher monthly payments.
Remember that long-term auto loans can be very expensive and carry real risks. Don’t be swayed by the promise of a low monthly payment!
3. Personal Loans Have Limits
Some lenders limit how much you can borrow for a personal loan. If your lender only allows you to borrow $20,000, a $40,000 vehicle will remain out of reach.
Car loans, on the other hand, are designed to put you behind the wheel. The better your financial history, the better the loan you’ll receive. Many car lenders will lend up to $100,000 or more, though most of us won’t be buying a vehicle that costs that much!
The Importance of Comparison Shopping
Generally, car loans will be the best way to purchase a vehicle. But they’re not the only option, which is why it may help to look into personal loans under the circumstances outlined above.
A strong credit history and a low debt-to-income ratio can help immensely when it comes to major purchases. But it never hurts to shop around, either. Comparing the rates of personal and auto loans can lead you to a funding option that fits your budget.