Buying a car is a big financial decision. If you’ve decided on your next vehicle but need help financing the purchase, getting a loan to buy a car is a common solution.
An auto loan is a classic way to buy a car, but can you also use a personal loan to buy a car? The short answer is yes, but there are a few caveats you should know before taking out a personal loan to purchase your vehicle.
Auto loan vs personal loan: what’s the difference?
Auto loans are installment loans that are used specifically for the purchase of a vehicle, such as a car or a motorcycle. When you take out a car loan, you agree to repay the lender within an agreed timeframe for the principal balance of the loan you borrowed, plus interest.
Typically, factors such as your credit score and the down payment factor determine whether you are approved for a car loan. These loans use your car as collateral, so if you are unable to make your installment payments, the lender may choose to repossess your car. In return for the secured loan, auto loan borrowers may see lower interest rates and longer repayment terms, which can help make monthly payments more manageable.
Personal loans are also installment loans that you pay off over time. However, unlike auto loans, personal loan funds can be used for many different needs including debt consolidation and emergency spending. Personal loans are generally unsecured, so if you use one to finance the purchase of your vehicle, you are not required to use your newly acquired vehicle as collateral.
However, since unsecured loans present a higher risk of default for lenders, you may see higher interest rates and shorter repayment terms for this type of loan.
Things to consider when choosing an auto loan versus a personal loan
Taking out a loan is an important step, potentially requiring years of regular payments. Before taking out a personal loan or an auto loan, be sure to consider the factors that will determine your eligibility, your rate, and more.
Credit score / history
Your credit score is one of the main factors lenders use to calculate your rate: the higher your credit score, the lower your APR. Many lenders also have minimum credit score requirements, especially for unsecured loans. Car buyers with bad credit may have a better chance of getting approved for an auto loan than a personal loan because an auto loan is secured by collateral.
Type of car you want to buy
Since auto lenders use your car as collateral, there are more restrictions on what type of car you can buy with the loan. If you default, lenders want to know that the vehicle is valuable.
Personal loans, however, can be used at your discretion, so there are no restrictions on your vehicle’s age or condition. For example, if you want to buy a model to renovate or an older model, you might be better off having a personal loan.
term of the loan
Auto loans are specifically designed for the purpose of buying a car, so loan terms are longer than personal loans. For example, auto loan terms are typically between 36 and 72 months. Personal loans, on the other hand, can require you to pay off the loan in as little as a year. While it’s best to choose the shortest term you can afford, longer terms will lower your monthly payments.
The benefits of financing a car with a personal loan
Depending on your situation, a personal loan may be the best option to finance the purchase of your vehicle. Some of the benefits of using a personal loan include:
- Quick access to cash. You can receive the money in a matter of days and you don’t have to find the vehicle you plan to buy first. This is useful if you want to use a loan to buy a car from a private seller.
- No guarantee. While some personal loans are secured, many are not. If you have good credit, you may be eligible for an affordable unsecured personal loan that won’t put your car at risk if you can’t make payments.
- Use the funds as you see fit. Personal loans do not require you to use the funds in a specific way like auto loans do. If you change your mind about buying a car, you can pay off the loan immediately or invest the money in another purchase.
Disadvantages of financing a car with a personal loan
Getting a personal loan to buy a car is not the best option for everyone. Before taking out a personal loan, consider the following:
- Higher interest rates. Since there is no collateral that personal lenders can fall back on, they typically charge higher interest rates than auto lenders.
- Less time to repay. Depending on the personal loan terms for which you qualify, you may need to repay the entire loan, plus interest, quickly.
- Lower loan amount. Since auto loans are for the purchase of vehicles, you may be eligible for a higher loan amount to cover the cost of the car. However, personal loans usually have a loan limit that may or may not cover your entire car purchase.
Do you have to take out a personal loan to buy a car?
Whether you need to take out a personal loan to buy a car depends on your particular situation. Consider the type of vehicle you’re interested in, your credit rating, your budget, and your ideal repayment schedule.
Whatever type of loan you choose for your car purchase, it is a good idea to compare the offers of several lenders. You can also use calculators to determine how much your loan will cost; try getting started with Bankrate’s personal loan calculator and car loan calculator. Ultimately, the best loan for you will offer you a low rate and good terms to make paying off your new car as easy as possible.