Picture this: you've found your dream car, and now you're weighing the options between a personal loan and an auto loan.
Our comprehensive "Personal Loan vs. Auto Loan" guide explores the key differences, pros, and cons of personal loans and auto loans, specific scenarios where one option might be more suitable than the other, providing valuable insights to help you navigate the car-buying process with confidence.
Key Differences: Personal Loan vs. Auto Loan
Let's take a closer look at the main factors that distinguish personal loans from auto loans:
Personal Loan: A personal loan provides flexible borrowing opportunities that cater to a range of needs, such as consolidating debts, making home improvements, or even financing a vehicle.
Auto Loan: The primary purpose of an auto loan is to facilitate the purchase of a vehicle, whether it is brand new or previously owned.
Personal Loan: To qualify for a personal loan, you generally need a good to excellent credit score, as lenders assess your creditworthiness based on your credit history and financial situation.
Auto Loan: Auto loans tend to have more flexible credit score requirements, making them accessible to a broader range of borrowers, including those with less-than-perfect credit.
Personal Loan: The majority of personal loans are unsecured, which implies that you are not required to offer collateral as security for the loan.
Auto Loan: Auto loans are categorized as secured loans, where the vehicle you purchase acts as collateral. In the event of loan default, the lender retains the right to repossess the car.
Typical Term Length
Personal Loan: Ranging from 12 to 84 months.
Auto Loan: Between 36 and 72 months, though some lenders offer extended terms up to 84 months or more.
Typical Loan Amount
Personal Loan: Personal loan amounts can vary widely, but they usually range from $1,000 to $50,000.
Auto Loan: Auto loan amounts depend on the vehicle's cost, with some lenders financing up to 100% of the car's value.
Typical APR Range
Personal Loan: Personal loans tend to have higher interest rates, usually ranging from 6% to 36% APR, depending on your credit score and financial situation.
Auto Loan: Auto loans generally have lower interest rates, typically ranging from 3% to 10% APR.
Personal Loan: Personal loans usually don't require a down payment.
Auto Loan: Auto loans often require a down payment, which is typically between 10% and 20% of the vehicle's cost.
Personal Loan: Personal loans may come with origination fees, prepayment penalties, or late payment fees.
Auto Loan: Auto loans can include fees such as loan origination fees, documentation fees, and registration fees.
Personal Loan: A personal loan used for purchasing a car doesn't come with any vehicle restrictions, as it can be used for any purpose.
Auto Loan: Based on their specific policies, lenders may impose vehicle restrictions on auto loans, including age and mileage limits.
Where Can You Get
Personal Loan: Personal loans can be obtained from banks, credit unions, and online lenders.
Auto Loan: Auto loans are available through banks, credit unions, online lenders, and dealerships.
Application Process: Which One is Easier?
Personal Loan: It is typically easier and quicker, especially if you apply online.
Auto Loan: It may be more involved, as it requires additional documentation and verification, such as proof of income and the vehicle's details.
Using a personal loan to buy a car: How does it work?
If you're considering using a personal loan to finance your car purchase, it's crucial to understand the process and what you need to qualify.
The Process of Using a personal loan to Buy a Car
- Research and compare personal loan lenders: Start by researching various personal loan lenders to find the best interest rates and terms. Consider banks, credit unions, and online lenders to see which one suits your needs.
- Apply for a personal loan: Once you've chosen a lender, complete the application process by providing the necessary information, including your personal details, income, and credit history. The lender will then review your application and determine your eligibility.
- Receive funds: If approved, you'll receive the funds as a lump sum, either via direct deposit or as a check. You can use this money to pay for your car purchase.
- Purchase the vehicle: Once you have obtained the loan amount, you have the flexibility to purchase your desired vehicle from various sources, including dealerships, private sellers, or even auctions. Since you've essentially become a "cash buyer," you may have more room to negotiate on the price.
- Repay the loan: Once the car is purchased, you'll need to repay the personal loan over the agreed term, including interest and any fees.
Personal Loan Qualification Requirements For a Car
- Credit score: Personal loans usually require a good to excellent credit score. A minimum credit score of 660 is often needed, but a score of 720 or higher will help you secure the best interest rates.
- Income: Despite no fixed income threshold for personal loans, lenders generally prioritize applicants with a stable and verifiable income source. Increasing your income level enhances the probability of loan approval and opens up opportunities for more favorable loan terms.
- Employment status: To meet the requirements of most lenders, it is typically necessary to provide evidence of consistent employment for a minimum of two years. This can include full-time, part-time, or self-employment as long as the income remains stable.
- Debt-to-income ratio (DTI): Lenders often prefer a DTI of 36% or lower, but some may accept applicants with a DTI up to 43% or higher, depending on other factors, such as credit score and income.
- Credit history: A credit history of at least three years with a good track record of on-time payments will improve your chances of getting approved for a personal loan.
Using an auto loan to buy a car: How does it work?
The Process of Using an auto loan to Buy a Car
- Research and compare auto loan lenders: To identify the most advantageous interest rates and favorable terms, it is wise to start your search by delving into a comprehensive exploration of diverse auto loan lenders, including banks, credit unions, online lenders, and dealership financing options.
- Get preapproved for an auto loan: Before you start shopping for a car, it's a good idea to get preapproved for an auto loan. This will give you a better idea of your budget and provide you with more negotiating power at the dealership.
- Choose your car: Once preapproved, visit dealerships or individual sellers to find the car that fits your needs and budget. Ensure that the vehicle's price falls within the preapproved loan amount.
- Finalize the loan: After selecting a car, provide the lender with the necessary documentation, such as the purchase agreement, vehicle identification number (VIN), and proof of insurance. The lender will then finalize the loan details and disburse the funds directly to the seller.
- Repay the loan: With the car purchased, you'll need to repay the auto loan over the agreed term, including interest and any fees.
Auto Loan Qualification Requirements For a Car
- Credit score: Auto loans generally have more flexible credit score requirements. A minimum credit score of 580 may be acceptable for some lenders, while a score of 660 or higher will help you secure better interest rates.
- Income: Many lenders require a minimum gross monthly income of at least $1,500 for auto loan approval. However, this requirement may vary depending on the lender and your credit score.
- Employment status: Typically, lenders will ask for evidence of steady employment spanning a minimum of one year. As long as the income is consistent and comes from reliable sources such as full-time or part-time employment or self-employment, it is usually considered acceptable.
- Debt-to-income ratio (DTI): When it comes to auto loans, lenders generally favor a Debt-to-Income (DTI) ratio of 45% or less. However, based on factors inclusive of credit score and income stability, some lenders may accept applicants with a DTI of up to 50%.
- Credit history: The approval likelihood of an auto loan application can be positively influenced by a strong credit history that spans at least two years with responsible credit usage, timely payments, and commendable credit habits.
When is a personal loan better than a car loan for buying a car?
You’re buying an older vehicle
Auto loans often have restrictions on the age of the car you can finance. If you're looking to buy an older vehicle, a personal loan might be the only option, as it doesn't have any vehicle age restrictions.
You want to buy a high-mileage car
When buying a high-mileage car, it's worth noting that some auto loan lenders may impose mileage limits. However, by choosing a personal loan, you can secure the necessary funds without being bound by any mileage restrictions.
You’re buying from an individual rather than a dealer
When buying a vehicle from a private seller or participating in an auction, a personal loan offers greater flexibility compared to auto loan lenders, who often require purchasing from a dealership.
You have good or excellent credit
If you have a good or excellent credit score, you may qualify for lower interest rates on a personal loan. This can make a personal loan more cost-effective than an auto loan, especially if you're buying a used car that might have a higher auto loan interest rate.
You don’t have the money for a down payment
Auto loans often require a down payment, which can range from 10% to 20% of the car's price. Personal loans, on the other hand, usually don't require a down payment, making them a more accessible option if you don't have the funds for a sizable upfront payment.
You want to avoid the risk of repossession
Since auto loans are secured by the vehicle, defaulting on the loan could result in repossession. With a personal loan, there's no risk of losing your car to repossession, as the loan is unsecured.
Pros And Cons Of Using A Personal Loan To Buy A Car
Pros Of Using A Personal Loan For A Car
- No down payment
- No car restrictions
A personal loan liberates you from any constraints regarding the age, mileage, or make and model of the car you desire, allowing you to find a vehicle that caters to your individual needs and preferences.
- No chance of car repossession
Since personal loans are unsecured, there's no risk of your car being repossessed if you default on the loan.
- Flexible loan terms
Personal loans generally offer more flexible terms than auto loans, allowing you to choose a repayment period that works best for your financial situation.
Cons Of Using A Personal Loan For A Car
- Higher interest rates
Personal loans often have higher interest rates than auto loans, especially for borrowers with lower credit scores. This can result in higher overall costs over the life of the loan.
- More qualification restrictions
The eligibility standards for personal loans may be more demanding, particularly in terms of higher credit scores, thereby creating increased difficulty for certain borrowers to secure approval.
- Additional loan fees
Personal loans may have additional fees, such as origination fees or prepayment penalties, which can increase the overall cost of borrowing.
- No tax benefits
Interest paid on personal loans is not tax-deductible, unlike interest paid on some auto loans.
When is an auto loan better than a personal loan for buying a car?
You’re buying a newer vehicle
Auto loans typically offer better interest rates for newer vehicles, so if you're planning to buy a new or relatively new car, an auto loan may be more cost-effective.
You’re purchasing a new car from a dealership
Dealerships often work with lenders to provide special financing offers or incentives on new cars. By using an auto loan, you may be able to take advantage of these promotions, saving you money on your purchase.
You need to borrow more money
Auto loans can often provide larger loan amounts than personal loans, making them a better choice if you need to borrow a substantial sum to finance your car purchase.
You need a longer repayment term
Auto loans generally offer longer repayment terms than personal loans, which can help reduce your monthly payments.
You have a more moderate credit score or DTI
Auto loans tend to exhibit a higher degree of flexibility toward credit scores and debt-to-income ratios. Individuals with moderate credit scores or higher DTIs are more likely to meet the eligibility requirements for an auto loan as opposed to a personal loan.
You can make a down payment
With the ability to make a down payment, an auto loan presents the opportunity to secure lower interest rates and more advantageous terms in comparison to a personal loan.
Pros And Cons Of Using An Auto Loan To Buy A Car
Pros Of Using An Auto Loan To Buy A Car
Auto loans typically offer lower interest rates than personal loans, especially for new or certified pre-owned vehicles, making them more cost-effective in many cases.
- Less restrictive qualifications
Auto loan lenders may have more flexible credit score requirements and be more lenient with debt-to-income ratios, making it easier for some borrowers to get approved.
- Availability through dealerships
Dealerships often have relationships with multiple lenders, making it convenient to secure financing directly through the dealer when purchasing a car.
- Manufacturer incentives and promotions
Opting for an auto loan can provide the opportunity to benefit from exclusive incentives or promotions extended by car manufacturers, inclusive of cash rebates, low-interest financing, or extended warranties.
Cons Of Using An Auto Loan To Buy A Car
- Need a down payment
- Risk of car repossession
In the event of default on an auto loan, the vehicle put up as collateral may be repossessed, as auto loans are secured by the car itself.
- Car restrictions
When considering an auto loan, it is crucial to be aware that lenders are likely to impose particular limitations on the car's make and model, mileage, or age, potentially narrowing down your choices for a vehicle.
- Longer loan terms
While longer loan terms can reduce your monthly payment, they also mean you'll pay more in interest over the life of the loan.
In the "Personal Loan vs. Auto Loan" article, we examined the pros and cons of each financing option for car purchases. Personal loans offer flexibility, no down payment requirements, and no repossession risk, while auto loans provide lower interest rates and easier approval and are available through dealerships.
Ultimately, the decision between a personal loan and an auto loan should be based on factors such as the borrower's credit score, financial needs, and the type of vehicle they wish to purchase.
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