If you want to buy a car, but can’t afford a cash purchase, you have a few financing options. Two popular choices are personal loans and car loans — which is best depends on the type of car and your personal preference. While car loans can only be used to finance car purchases, personal loans can be used to cover a wide variety of expenses.
Consider key differences, examine pros and cons, and explore situations where using a personal loan may be more advantageous than a car loan, and vice versa.
Before deciding whether to finance a car purchase with a car loan or a personal loan, it’s helpful to understand how these two types of loans work and what is expected from you as a borrower.
Personal loans typically have flexible repayment terms, allowing borrowers to choose a loan term that suits their financial situation. Repayment terms typically range from one to seven years, depending on the lender. This flexibility provides an opportunity to tailor the loan to fit your budget and repay at a comfortable pace.
Car loans are somewhat less flexible when it comes to repayment and usually have loan terms ranging from three to six years.
The annual percentage rate (APR) for personal loans and car loans can vary depending on factors such as your credit score, income, and the lender’s terms. Generally, personal loan APRs range from around 6% to 36%, with the average personal loan interest rate around 17% for a five-year personal loan, based on Credible prequalification data.
This is much higher than the average loan rates on both new and used cars, which were 7% and 11%, respectively, according to Edmunds data.
Auto loans often come with lower interest rates than personal loans because they’re secured by your car, which reduces the lender’s risk. Personal loans, on the other hand, are not secured by your car nor, often, any other collateral, and so rates tend to be higher.
Regardless of which type of loan you go with, it’s important to shop around for the best rate and lowest fees, and negotiate with lenders to secure a competitive deal.
Personal loans are generally unsecured — meaning they don’t require any collateral, like your car or home. This can be a big benefit if you don’t want to pledge a specific asset as security. However, unsecured loans often have higher interest rates to compensate for the increased risk the lender takes on.
Car loans, on the other hand, are secured by the vehicle you’re purchasing. If you default on the loan, the lender can repossess your car to recover its losses. This extra layer of security for the lender often results in a lower interest rate for you.
Another major benefit of personal loans is that they don’t require a down payment, since they are not tied to a specific purchase. This makes personal loans a solid option if you don’t have funds available for a down payment.
Car loans usually require a down payment, which may range up to 20% of the car’s purchase price. Making a substantial down payment can lower your monthly payments and reduce the overall interest paid over the life of the loan. Some lenders may offer zero-down payment options, albeit with higher interest rates.
Before taking out a personal loan to buy a car, consider the following:
Auto loans have their own unique set of advantages and disadvantages to consider before applying for one.
Auto loans offer distinct advantages over personal loans for car buying. Here are some scenarios where choosing an auto loan may be the wiser option:
Using a car loan is often the better way to buy a car, but under these circumstances, it can make sense to use a personal loan instead.
Before choosing a car loan or a personal loan, it’s essential to compare offers from different lenders and carefully evaluate the terms, interest rates, and total cost of borrowing, said Ryan McCarty, a certified financial planner and lead adviser at Castle Rock Investment Company.
“Don’t forget that the bank you traditionally do business with may have an auto loan program that you can use to compete with the dealership,” McCarty said. “Ultimately, the decision between an auto loan and a personal loan should be based on your financial situation, creditworthiness, and preferences.”