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Car prices remain elevated in 2023 due to the persisting impact of the pandemic. The average loan amount for a new car is now $40,657 while used car loans average $26,863, both all-time highs, according to Experian's State of the Automotive Finance Market for the second quarter of 2023. With the cost to purchase a vehicle so high, nearly 80% of new car buyers and 38% of used car buyers are financing their purchases.
Usually, auto loans are your best bet for financing, whether through the dealership, your credit union or another financial institution. However, personal loans are another option that may make sense under the right circumstances. It's often possible to use money from a personal loan to buy a car, but you should be aware of the pros and cons of doing so before choosing this route.
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Can I Use a Personal Loan to Buy a Car?
As long as you meet a lender's loan qualifications, you can use a personal loan to buy a car. But should you? Generally, auto loans are a better option because they usually offer lower interest rates than personal loans.
Experian's latest Automotive Finance Market report lists the average auto loan interest rate at 6.63% for new cars and 11.38% for used cars. These auto loan averages are lower than the 12.17% average interest rate on a 24-month personal loan, according to the Federal Reserve. If you want to spread your personal loan payments out over a longer term, you may pay a higher rate. Generally, personal loan interest rates can range from the single digits to 35% or higher, with terms on personal loans ranging from six months to 84 months.
Still, you may prefer to use a personal loan to buy a car if you don't want to offer up collateral on your loan or plan on using the loan funds for additional purposes beyond buying the vehicle.
Personal loans offer high borrowing limits of up to $100,000 for eligible borrowers and can be used for nearly any purpose, even buying a car. However, higher interest rates and tighter credit requirements may mean a personal loan isn't your best option to buy a car.
Personal Loan vs. Auto Loan: Key Differences
The primary difference between these two loan types is collateral. Most personal loans are unsecured, and you can typically obtain one without offering up collateral. By contrast, auto loans are secured loans that require you to use the vehicle being financed as collateral. If you default on the loan, the lender can take possession of the vehicle and sell it to recover some of their losses on the loan.
Since auto loans are collateralized, they present less risk to the lender, which translates to lower interest rates on auto loans versus personal loans.
Here are some of the core differences between personal loans and auto loans.
| Personal Loans vs. Auto Loans | ||
|---|---|---|
| Personal Loans | Auto Loans | |
| Collateral | Can be secured or unsecured, but collateral is usually not required | Secured by the financed vehicle |
| Loan use | Can be used for nearly any purpose | Can be used to purchase a vehicle |
| APR | Fixed or variable interest rates that can range from single digits to 35% or higher | Can range from single digits for new and used car buyers with good credit to rates up to 20% or more for those with poor or limited credit purchasing a used car |
| Term | Range from a few months to five years | Range from 36 to 96 months |
| Down payment | Not required | Often required |
Pros and Cons of Using a Personal Loan to Buy a Car
As with any financial decision, always weigh the benefits and downsides to help determine your best option.
Pros of Buying a Car With a Personal Loan
Personal loans generally provide fast funding, with some online-only lenders funding loans the same day or next day after approval. Personal loans also offer the following benefits:
- No down payment: Personal loans don't typically require you to come up with a down payment. By contrast, some auto lenders may require a down payment, especially if your credit score is low. Even if a down payment isn't required, putting some money down could lower your overall borrowing amount, which could lead to lower monthly payments and interest charges. Personal loans may require an origination fee, however, which is usually deducted from the loan amount.
- No collateral required: When you purchase a car in full with cash funds from a personal loan, the car title is in your name. If you default on the loan for any reason, your lender can't repossess your vehicle. Late payments and default will likely still result in severe credit score harm.
- Flexible use: You can use a personal loan for just about any reason, including to buy a car. If you have extra funds available after purchasing the car, you can use personal loan proceeds for other purposes. Personal loans usually cannot be used for college tuition, a down payment on a home or for business purposes.
- High borrowing amounts: Personal loan borrowing limits vary by lender and range from $100 to $100,000. Your eligibility will depend on your credit score, payment history, income and your debt-to-income ratio (DTI), among other factors.
Cons of Buying a Car With a Personal Loan
While a personal loan is a viable option to purchase a vehicle, you must understand its drawbacks before applying for one.
- Higher interest rates: Personal loans often have lower interest rates than some forms of credit, but they usually have higher rates than auto loans and other secured loans. Without collateral to secure the debt, lenders offset their risk by charging you higher rates to borrow money, with APRs as high as 36%.
- Shorter repayment terms: According to Edmunds, the most common auto loan term for both new and used cars is 72 months, or six years. For their part, personal loans are usually available in shorter terms ranging from 12 to 60 months. A shorter term means you'll pay less in interest over the life of the loan, but your monthly payments will be higher. Conversely, spreading your loan out over a longer term brings down your monthly loan payment, but you could pay more interest over time.
- More stringent eligibility criteria: Because personal loans are unsecured and carry a higher risk than a secured auto loan, they often have stricter eligibility requirements. Without collateral to offer as security, your lender may require you to have higher credit scores, stronger income or a lower debt-to-income ratio to qualify.
When Does It Make Sense to Use a Personal Loan for a Car?
Despite the advantages of buying a car with an auto loan, using a personal loan to buy a car can make sense in certain scenarios. For example, if you're dealing with a private seller, getting an auto loan from the dealer isn't an option, but a personal loan may have comparable terms with a bank or credit union auto loan.
You may also prefer a personal loan if you want to purchase a car without a down payment. And since you don't have to offer your car as collateral, a personal loan can help you avoid repossession of your car if you have trouble making your payments.
On the other hand, you should steer clear of personal loans in many situations, such as if you're on a tight budget. Personal loans typically come with higher interest rates and shorter repayment terms, both of which could lead to higher monthly payments. And even though the loan isn't secured by your car, your personal loan lender could garnish your wages or file a lawsuit against you to recover damages if you default on the loan.
Improve Your Credit to Lower Your Loan Costs
Whether you choose to buy a car with a personal loan or an auto loan, you'll likely receive a lower interest rate with good credit, and generally, the higher your credit scores, the better. Before you apply, take a moment to check your credit report and credit score for free with Experian. Address any issues you discover and implement strategies to improve your credit if necessary. Even a modest increase in your credit may help you qualify for a lower rate that could save money in the long run.