While it’s possible to use a personal loan to buy a car, it’s likely 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 could make sense — for instance, if you’re buying a car that’s 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 you can use for almost any purpose, including buying a car. They come with fixed interest rates, and repayment terms typically span from five to seven years.
Most personal loans are unsecured, so you don’t have to put up collateral. Instead, the lender evaluates your financial profile, including your credit and income, when you apply.
If you fall behind on payments, the lender can’t repossess your car. However, there can be other consequences, including late fees, collection activities, damage to your credit score, and even legal action.
On the plus side, many lenders offer fast funding on personal loans. You might get your funds the same day or the next day after approval.
Auto loans are designed to purchase a car and may be a more affordable option than a personal loan. They’re a type of secured loan that uses the car as collateral. Your car loan will specify what vehicle you’re using it to buy and include the vehicle identification number (VIN) in your loan documents.
Because car loans are secured, they may have less stringent eligibility requirements than personal loans — and come with 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 of a secured car loan is that the lender can repossess your car if you fall behind on payments. You may also need to make a down payment on the car upfront, whereas a down payment is not required for a personal loan.
Interest rates on car loans are often fixed, and repayment terms may span up to seven years. Your interest rates and approval odds depend not just 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 a co-signer: A guide for first-time buyers
Here’s 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 may be more expensive than an auto loan. Here’s why a personal loan may not be ideal for your car purchase:
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 go as high as 36%. The average rate on a car loan, on the other hand, 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.
Could come with a shorter repayment term: With some lenders, the maximum repayment term for a personal loan is limited to five years. Many auto loans span up to seven years, allowing you to space out repayment and have lower monthly bills.
Loan amounts may be limited: Lenders determine your personal loan amount based on several factors, including your credit score, income, and the purpose of the loan. You’re not guaranteed to qualify for the full amount you need to purchase your car.
Borrowing requirements may be stricter: Since most personal loans are unsecured, lenders may have more stringent credit, income, and debt-to-income ratio requirements than you’ll find with car loans. Without good credit (or a creditworthy co-signer), you might have trouble getting approved or could 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 a few scenarios where it could make sense:
You can’t qualify for a conventional car loan: A traditional auto loan isn’t available in all cases. For instance, some lenders won’t offer funds for cars that are more than a decade old or have over 100,000 miles. They also may not offer a loan if the cost of the car you’re buying is too low. Plus, you can’t get dealership financing if you’re buying from a private seller (though you could look for a car loan directly from a lender).
You have subprime credit: Poor credit can make it difficult to qualify for a traditional car loan. You can explore second-chance auto loans, but be aware that these usually come with high rates and fees. Some personal loan providers will work with bad-credit borrowers, though you’ll still be subject to higher rates and fees. In this situation, compare your subprime car and personal loan options to see which offers the better deal.
You don’t want to make a down payment: Some car loans require you to make a down payment upfront, whereas you don’t need one with a personal loan. The risk of not making a down payment, however, is that you could end up underwater on your loan, meaning you owe more than the car is worth.
You can get a better deal on 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 origination fees. It may be worth shopping around to see which loan type — a personal loan or a car loan — offers the lowest borrowing costs.
Personal loans offer flexibility and fast funding, but they often come with higher interest rates and shorter repayment terms compared to car loans. While you can use a personal loan to purchase a car, it’s likely not your most cost-effective option.
Regardless of the loan type you choose, it’s worthwhile to shop around and compare options from multiple lenders. By checking your rates through prequalification, you can review offers and find the best deal. Compare interest rates, repayment terms, loan amounts, and fees to find your most affordable loan.
This article was edited by Alicia Hahn.
