Key takeaways
- A personal loan can be a good idea to finance a used car if conventional financing isn’t available or if you can’t qualify for an auto loan.
- Rates can be higher and repayment terms shorter, compared to traditional auto loans.
- You may be able to avoid repossession of your vehicle if you default on a personal loan.
Unless you can pay cash, you’ll likely need to finance a vehicle. Most buyers do. However, an auto loan isn’t your only option.
Personal loans can be used for almost any purpose — including buying a car. Depending on the circumstances, it may even make more sense than getting an auto loan. That said, there are a few drawbacks to be aware of before choosing this option.
When to use a personal loan for a used car or new car
A personal loan isn’t most buyers’ first thought, but it could be useful in certain scenarios.
1. Conventional financing is not available for the vehicle
If you’re considering buying an older car, it may not always be possible to secure conventional auto financing. Some lenders may refuse to finance a vehicle that is more than 10 years old. You may also find that lenders require vehicles to have less than 100,000 miles.
2. Your credit is not good enough for an auto loan
If you have less-than-ideal credit, getting a car loan may be difficult. In some cases, you may only qualify for financing at a buy-here, pay-here lot, which can be extremely costly.
Borrowers who have a subprime credit score pay the highest interest rates. The average interest rate on a subprime car loan during the first quarter of 2024 was 18.97 percent for used cars and 12.85 percent for new cars, according to Experian.
Subprime lenders should only be considered if you have no other options available. Shopping for a personal loan may provide a better alternative. Some lenders even offer bad credit loans, which may result in a more competitive offer due to more flexible credit requirements.
It’s worth noting, though, that rates on bad credit personal loans also tend to be high. Borrowers with FICO scores between 630 and 689 receive average personal loan interest rates between 17.80 percent and 19.90 percent.
Before submitting a formal application, consider prequalifying for a loan with at least three lenders. This will allow you to compare real offers side-by-side and decide whether a personal loan is the best route, without impacting your credit.
3. Your personal loan rate is lower than an auto loan rate
Unsecured personal loan interest rates tend to be higher than auto loan rates. But if you have outstanding credit, you may qualify for a competitive interest offer. Some personal loans come with starting rates as low as 7.49 percent. That’s lower than the average super prime rate for a used car loan, which is 7.66 percent.
However, if you qualify for a low interest personal loan, you may also qualify for special auto loan deals as well. This could mean a significant rebate or even zero percent financing on your auto loan. So, make sure you check into both options to see which would be the smarter financial choice.
Using a personal loan vs. using an auto loan to buy a car
Auto loans and personal loans are similar in that they are both installment loans. That means you will make monthly payments over a set period of time. They both come with a fixed interest rate.
Your income and credit history will be key to getting approved with either type, but there are also some key differences.
| Personal loan | Auto loan |
|---|---|
| Can be secured or unsecured | Secured |
| Can be used for multiple purposes | Restricted to vehicle financing |
| Typically, higher interest rates and shorter loan terms | Lower interest rates and extended loan terms |
Using a personal loan
Personal loans can be used to cover the cost of different financial needs, from medical expenses to the costs of a wedding or debt consolidation and yes, a car purchase.
However, most personal loans are unsecured, meaning they don’t require collateral. Because the loan is riskier for the lender, the interest on a personal loan tends to be higher.
Additionally, the repayment timeline may be shorter. Most lenders cap loan terms to five years.
Using an auto loan
An auto loan is a secured loan specifically designed for buying a vehicle. The vehicle is collateral. This means the car can be repossessed if the loan becomes delinquent or you default.
Because of the lower risk, lenders tend to offer more favorable interest rates and terms on these loans. They also may offer loan terms of up to seven years, meaning a smaller monthly payment.
Pros and cons of using a personal loan to buy a car
Though personal loans can be a good alternative to finance a car, they may not be the right option for you. Consider the following factors when making a choice.
Pros
- Fast access to cash
- Some lenders offer next-day and even same-day funding. This can be useful if you want to use the loan to buy a car from a private seller, as you will be able to act quicker.
- No downpayment
- Though a down payment isn’t always required to get an auto loan, it’s often encouraged to help you get a lower interest rate. By using a personal loan, you avoid having to put 10 or 20 percent of the car’s purchase price to get a better loan.
- No collateral
- Although some personal loans are secured, many aren’t. If you have good credit, you may be eligible for an affordable unsecured loan. You won’t put your car on the line if you can’t make payments, though the lender could still sue you if you default.
Cons
- Higher interest rates
- Because there’s no collateral to reassure the lender, the average personal loan rate is higher than the average auto loan rate. Rates can be as high as 36 percent — though those rates aren’t unheard of for bad credit auto loans.
- Higher monthly payment
- Personal loans tend to have higher rates and shorter repayment terms. That means you could end up with a higher monthly payment than if you took out an auto loan.
- Limited amounts
- Personal loan lenders tend to limit loan amounts and term lengths based on creditworthiness. If you have poor credit, you may not be able to get a loan high enough to cover the full cost of your desired vehicle.
The bottom line
When buying a used car, a personal loan can sometimes be the way to go, rather than a traditional auto loan. This is especially true if you can’t qualify for traditional financing or if you want to own the title of your vehicle right away.
However, because these loans are often unsecured, they may come with higher interest rates and shorter repayment terms than many auto loans.
Before deciding, consider using a loan calculator to crunch the numbers and determine which option makes the most sense financially.
Read the full article here
