Buying a car can be great fun, but you’ll likely face at least some financial limitations. If you aren’t planning to pay cash for your car, you’ll need a plan for how to finance it.
An auto loan is the natural choice, but one other option you might consider is a personal loan. Auto loans and personal loans have key differences, however, and an auto loan will typically make more sense.
[Read: Best Personal Loans.]
Can You Use a Personal Loan To Buy a Car?
Yes, you can use a personal loan to buy a car. A personal loan can be used to buy almost anything not prohibited by the lender, says Ganesh Pandit, professor of accounting at Adelphi University.
What usually matters for approval is your perceived ability to repay the loan, not how you’ll use the money. The lender may ask the purpose of the funds when disbursing the loan, but this typically doesn’t affect the lending decision, says R.L. Shankar, an associate professor at Emory University and an expert in banking and finance.
That said, it may not be a good idea to use a personal loan for a car.
[Read: Best Bad Credit Loans.]
Personal Loans vs. Auto Loans
You can use a personal loan for expenses such as medical bills, home improvements and vacations, as well as for debt consolidation.
“A personal loan is exactly what the name suggests,” Pandit says. “It is a loan that can be used for any personal purpose.”
Auto loans, by contrast, are used specifically to purchase a vehicle.
Both personal and auto loans are installment loans, meaning you agree to repay the lender in fixed amounts over time. The key difference between personal loans and auto loans is that personal loans are unsecured while auto loans are secured using the vehicle as collateral.
Since personal loans aren’t backed by any collateral, they often have higher interest rates, which vary by lender and perhaps by location, Pandit says. According to the St. Louis Fed, in August 2024 the average interest rate for a two-year personal loan was 12.33%, while the average interest rate for a four-year auto loan was 8.40%. The slight difference in terms can create a vast difference in how much the loans cost.
For example, let’s say you need to borrow $10,000 to help purchase a car and you qualify for average terms. Here’s a breakdown of how much each option would cost:
Auto Loan
— Terms: 60 months, 8.40% interest
— Monthly Payment: $204.68
— Total Interest: $2,281.01
— Total Cost: $12,281.01
Personal Loan
— Terms: 24 months, 12.33% interest
— Monthly Payment: $472.28
— Total Interest: $1,334.65
— Total Cost: $11,334.65
The monthly payment on the personal loan is much higher, and extending the term would raise the total interest cost even higher. Likewise, the auto loan would likely be accompanied by a down payment, which would bring total costs down even further.
At the same time, auto loans have more lenient credit score requirements. You’ll want a credit score at least in the high 600s for a personal loan. Lower scores in the high 500s to low 600s might lead to higher interest rates or a denial. It’s possible to get an auto loan with fair or poor credit, though you’ll pay for it with a higher rate, and a score below 600 may get you declined.
“Of course, it is possible to get a secured personal loan, in which case most of these concerns — stricter credit score requirements and higher rates — are ameliorated to a large extent,” Shankar says. But like an auto loan, a secured personal loan requires collateral.
You may be able to lower your monthly payment on either a personal loan or auto loan by opting for a longer loan term, but this may lead to even higher interest rates. Some lenders won’t go over five-year terms for personal loans. You can get auto loans with terms of six or seven years — or even longer — but doing so is not a good idea.
With an auto loan, the lender technically owns your car until you’ve paid off the loan. Having a lien on your vehicle means you can’t resell it without involving your lender. And if you default on your loan, the lender can repossess your vehicle.
If you default on a personal loan, the lender’s only recourse is through the courts and bankruptcy proceedings. “This isn’t a pro or con, but something that many people are not aware of,” Shankar says.
[Read: Best Low-Interest Personal Loans]
Pros of Using a Personal Loan to Buy a Car
— No down payment. Personal loans do not require a down payment, while auto loan lenders may require one if you have a low credit score.
— Fewer restrictions. You can buy any vehicle using a personal loan, regardless of the car’s age or mileage.
— Vehicle isn’t collateral. The title of the car is in your name, with no lien on the vehicle, so the lender can’t take possession of your car if you default on the loan.
Cons of Using a Personal Loan to Buy a Car
— Higher interest rates. Personal loans tend to have higher interest rates, especially for borrowers with lower credit scores.
— Stricter qualification standards. It can be harder to qualify for an unsecured personal loan.
Should You Ever Use a Personal Loan to Buy a Car?
Auto loans are generally easier to qualify for and less expensive than personal loans. Given that, would it ever make sense to use a personal loan to buy a car?
Generally, Pandit and Shankar are against using personal loans for car purchases, but there are a few circumstances when a personal loan may be the only option.
Circumstances when you might have to use a personal loan for a car purchase include:
— If you aren’t able to meet down payment or loan-to-value ratio requirements from your auto lender
— If you want to buy an older used car the auto lender isn’t willing to finance
— If the auto loan lender insists on a minimum loan amount that’s higher than the amount you want to borrow
— If you want to hold the title
Though an auto loan is usually a better choice, the type of vehicle you wish to purchase and the limitations or requirements of each loan type will help determine which option is right for you.
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Can You Buy a Car With a Personal Loan? originally appeared on usnews.com
Update 10/29/24: This story was published at an earlier date and has been updated with new information.
