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Personal loans can be used for almost anything, but they’re usually not a good way to finance a car.
Auto loans aren’t the only type of loan that could help you buy a new or used car. Personal loans are another type of loan that can be used for personal expenses, including car purchases.
Understanding the different features of personal loans and car loans will help you know when it might be a good idea to use each loan.
Personal loans and auto loans are both installment loans, but besides that, they are pretty different. Personal loans are a way to borrow money for personal expenses, although auto loans are made only to finance vehicles. Here’s a breakdown of each loan type:
Personal loans are loans you can use for practically any personal reason, such as home remodels, debt consolidation, or making a major purchase like a car. After getting approved for a personal loan, funds typically are deposited into your bank account, and you can use that cash to buy your new ride.
Personal loan rates and payments are often fixed, making them a convenient way to pay off debt. Loan repayment terms generally range from 12 to 60 months, depending on the lender you choose, giving you a short or an extended period to eliminate the balance.
Personal loans are typically unsecured, so you don’t have to pledge collateral to back the loan. Instead, your signature promising repayment is enough to get funding. If you use funds from an unsecured personal loan to buy a car, you might immediately get the title and own the car outright. And if you don’t make payments, your credit will be affected, but the lender doesn’t have the right to come after your assets to pay off the debt (unless they sue you and win the case).
The drawback of unsecured loans is that rates can be higher than rates for secured loans, especially if you have bad credit. Rates on personal loans from many online lenders and banks go as high as 36% APR.
Personal loans
Pros of personal loans
The pros to using a personal loan to finance your car purchase are:
Cons of personal loans
The cons of using a personal loan include:
Auto loans
Auto loans are loans designed to finance cars, and typical auto loan terms range from 36 to 84 months.
In some cases, lenders could require that you make a down payment that could be a percentage of the purchase price. Interest on an auto loan might be fixed or variable, and loans are secured by your vehicle. Because your car acts as collateral, auto loans could have lower interest rates than personal loans, but if you don’t make your monthly car payments, there’s a risk of repossession.
Auto financing through manufacturers might come with special perks, like low interest or 0% APR for a certain period. However, dealers and manufacturers aren’t the only places where you can secure financing — banks, credit unions, and online lenders might also offer auto loans with competitive rates.
The process of applying for and using a car loan to buy a car depends on where you get financing from. If you work directly with a bank, credit union, or another lender, you apply, get your cash, and use it to buy your car. In other cases, the whole buying and financing process usually happens at the dealer.
One extra cost to consider when taking out an auto loan is that lenders could require you to maintain full coverage insurance to protect the car until the loan is paid off. Full coverage insurance is a policy that includes liability, comprehensive, and collision, which can be more expensive than just a liability policy.
Auto loans
Pros of auto loans
The pros of using a car loan to finance your next car include:
Cons of auto loans
The cons of choosing a car loan are:
When to Use a Car Loan to Finance a Car
In most cases, car loans are the best way to finance a vehicle. That’s because rates might be lower and you could qualify for financing incentives that make them cheaper than personal loans.
Even borrowers with poor credit history could qualify for a car loan with an interest rate lower than a personal loan, since having the car as collateral protects the lender from some risk.
According to the Consumer Financial Protection Bureau (CFPB), banks might give car loan rates of 10% to borrowers with bad credit, and financing companies or “buy-here-pay-here” dealerships might offer 15% to 20%. This is high — but lower than the 36% you might get on a personal loan when you have bad credit.
A personal loan could be used to buy a car in situations where you can’t get a car loan. If you’re trying to buy a classic or unusual car, you might have trouble finding an auto lender to help you finance it. In this scenario, you could consider a personal loan for the purchase.
If you’re buying an inexpensive car that you plan to pay off quickly, going with a personal loan could be a good way to buy a car without a down payment. But consider that the origination fee could be high and credit matters. If you don’t have a decent credit score, you could qualify for a personal loan with high rates and fees, increasing your payments and overall cost.
It’s also important to watch out for small instant and payday loans marketed as a quick option for borrowers with bad credit. These predatory loans can have triple-digit interest rates and should be avoided for any purchase because payments can be hard to manage. If you have trouble paying off the debt, fees can grow your balance, leading to a debt trap that’s difficult to overcome.
Personal loans aren’t bad — using one could be a good way to pay for a major event, bill, to consolidate debt, or make a major purchase. But auto loans have features that make them better to use for car purchases and should be explored first when you want to borrow money for a new ride.
Applying for a car loan with a cosigner could help you qualify for a better rate if you have bad credit. And if you’re unhappy with your monthly payment, rate, or term length after borrowing, you could be able to refinance your car loan to get better terms.
Refinancing is the process of paying off your existing car loan with a new loan to change the loan terms in some way. According to RateGenius data from April 2022, borrowers who refinanced saved an average of $83.82 per month, which works out to over $1,000 per year.
When refinancing a car loan, lenders will review factors like your credit, income, and loan-to-value (LTV) ratio. LTV ratio is the percentage of your car’s value that’s covered by a loan and having an LTV higher than 125% could make it harder to qualify for loan refinancing.
However, different lenders are willing to refinance loans for borrowers with different LTV ratios and credit profiles. If you’re considering refinancing your car loan, you can share information about your financial situation and shop for rates from a network of lenders using a marketplace like RateGenius.
Whether you choose a personal or auto loan, comparing offers before borrowing money is important. Rate shopping for loans is just like window shopping for your next TV.
Shopping helps you find the best loan offers on the car you want to buy, which is important because payments could stick around with you for the next several years. Consider creating a spreadsheet that lists these loan terms for each loan you’re weighing:
Then compare each loan head-to-head to see where you’ll be able to land the most savings. The good news is that some lenders will let you pre-qualify for car and personal loans without a hard credit check, so you don’t have to worry about your credit taking a hit when rate shopping and reviewing loan terms.
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