Personal loans vs. auto loans
Both can be used to buy a car, but auto loan rates are usually lower
Comparing a personal loan with an auto loan when buying a car may feel like comparing forks with spoons. The two tools are used to achieve the same fundamental objective, but their distinctions make them suited to different circumstances.
Both personal loans and auto loans provide a lump sum of money that you pay back over time with interest. But auto loans are typically secured by the vehicle you're purchasing, while personal loans are unsecured. Auto loans also tend to have lower interest rates, but personal loans offer more flexibility in how you can use the funds.
Wondering which is right for you? Here’s how to choose between personal loans and auto loans for your next car purchase.
Key insights
- Both personal loans and auto loans can be used to buy a car, but your personal circumstances and the loans’ terms and interest rates will determine which is best for you.
- While personal loans provide flexibility, they typically have high interest rates and only make sense for those with high credit scores.
- Auto loans use the car as collateral, so they often have lower interest rates and can be more accessible for buyers with low credit scores.
What to know about personal loans
Personal loans can be used for a multitude of things, like vacations, home improvement projects, consolidating debt, medical bills and more. When you’re approved for a personal loan, the funds come from a lending institution in a lump sum, with the expectation that you’ll pay it back via set payments over a set amount of time.
Personal loans are usually unsecured, so they don’t have collateral like a car or house backing them up.
Here are some other important characteristics of personal loans:
- Ideal borrower: A personal loan can work well for someone who has a strong credit score but doesn't have a down payment saved up for a car. It may also be suitable if you want to buy a car under $5,000 or a car that’s too old to qualify for an auto loan.
- Minimum and maximum loan amounts: Personal loans typically range from $1,000 to $100,000, though many institutions cap their lending at $50,000.
- Minimum and maximum terms: Personal loan terms typically range from 12 to 60 months.
- Minimum credit score: While the credit score requirements vary by lender, 660 is a common minimum. However, some lenders may go as low as 580.
- Interest rate range: Personal loan interest rates currently range from around 8% to 36% (as of publication). According to the Federal Reserve Bank of St. Louis, the average rate on 24-month personal loans is 11.48% as of May 2023.
- Approval time: Depending on the lender, approval for a personal loan can take one to seven days.
» COMPARE: Best personal loans
Pros and cons of personal loans
No one financing option is a great fit for everyone. If you’re considering buying a car using a personal loan, explore the pros and cons before you fill out an application.
Pros
- Fast approval times
- No collateral
- No down payment
Cons
- Good credit required
- Relatively high rates
- Small loan amounts
» MORE: Should I get a personal loan?
What to know about car loans
Car loans are only used to finance vehicles. These loans are secured loans, backed by the car. Since the vehicle can be repossessed if you stop making payments, there is less risk for lenders if you default on the loan.
You don’t necessarily need a good credit score to get an auto loan, but it does help. You’ll make payments in fixed monthly installments. The shorter the loan term, the higher your monthly payments, but the less you’ll pay in interest over time.
For example, if you get an auto loan for $10,000 with a 5% interest rate and a 36-month term, you’ll end up with a monthly payment of about $300, and you’ll pay about $790 in total interest over the life of the loan. If you agree to a longer loan term of 72 months, you’ll have a monthly payment of about $161, and you’ll pay about $1,596 in total interest over the life of the loan.
Here are some important characteristics of auto loans:
- Ideal borrower: An auto loan may work well for someone who has a weak credit score but healthy savings for a down payment.
- Minimum and maximum loan amounts: Car loans commonly have high loan limits, ranging from minimums of $5,000 to maximums of $100,000.
- Minimum and maximum terms: The most common terms available range from 36 to 84 months.
- Minimum credit score: While there’s no universal minimum, borrowers with a lower score will have to pay higher interest rates.
- Interest rate range: According to Statista, the average interest rate on 60-month new car loans is 7.4% as of August 2023. However, rates can go as high as 20% or more, depending on your credit score and whether the car is new or used.
- Approval time: Depending on the lender, you can be approved for a car loan in less than one minute.
Auto loans are the most common way for someone to purchase a car, given their flexible terms and lack of credit score restrictions.
» COMPARE: Best car loan companies
Pros and cons of car loans
Because car loans typically offer lower interest rates than personal loans, they usually make more sense when buying a vehicle. But before opting for a dealer loan, check out car loans from your bank or credit union, which can sometimes provide you with better deals and more savings.
Pros
- Lower interest rates
- Flexible credit requirements
- Flexible lending terms
- Unique financing opportunities
Cons
- Serious consequences if you default
- Down payment requirements
- Interest rate factors
- High dealer markups
While dealerships may offer unique financing, Michelle Delker, a certified public accountant and the founder of The William Stanley CFO Group, says to be careful.
“Incentives and promotions in the auto industry, such as 0% APR financing or cash rebates, can make auto loans more appealing. However, prospective borrowers should meticulously consider the overall financial effect of specials before making a choice,” Delker warned.
» MORE: How to buy a new car
Alternatives to personal loans and auto loans
If a traditional auto or personal loan isn’t a good option, there are other ways to finance a car. Just make sure the loan isn’t predatory and that you’ll be able to pay off the car in a reasonable amount of time while maintaining your credit score.
Auto loans from “no credit, no problem” dealerships
Paying with a credit card
But if you can’t pay off the card immediately, your debt could spiral out of control given credit cards’ high interest rates. Also, not all dealerships take credit cards, and some have a cap on the maximum credit card transaction they’ll allow.
Borrowing from a loved one
Compare personal loans and auto loans
When it comes to picking an auto loan or personal loan to buy a car, there isn’t a “good” or “bad” choice. Rather, there are financial or credit scenarios that make one type of loan more appealing than the other.
Things personal loans and auto loans have in common
Personal and auto loans have these things in common:
- Both personal loans and auto loans can be used to finance the purchase of a car.
- Both can have fast approval times, with some lenders offering same-day or next-day funding.
- Borrowers with a credit score of 670 or higher, a steady income and little existing debt are more likely to get the best rates on both types of loans.
How personal loans and auto loans differ
There are more differences than similarities between these two types of loans. Take the time to consider and research which one may be the best fit for you.
- Auto loans typically have better interest rates than personal loans, in part because they are secured by the car you're purchasing.
- Auto loans require collateral (the car) while personal loans can be unsecured.
- Borrowers with a credit score under 670 are more likely to get approved for an auto loan than a personal loan.
- Personal loans can be used to purchase cars that don't qualify for auto loans.
- When you buy a car with a personal loan, you own it outright from the start.
- Dealerships may offer unique financing deals for auto loans, but not for personal loans.
- If you don't pay back your auto loan, your car can be repossessed.
- You may need a down payment of at least 10% for an auto loan.
- Dealerships may apply a markup to auto loans, while personal loans don't have intermediary markups.
FAQ
Can you use a personal loan to buy a car?
Yes, you can use a personal loan to buy a car. If you don’t have a down payment saved but have great credit, taking out a personal loan could be a good option for buying a car.
Is it easier to get a personal loan or an auto loan?
It’s generally easier to get an auto loan than it is to get a personal loan. Auto loans are secured loans, so lenders will accept borrowers with lower credit scores, making them easier to obtain.
Can I pay cash for a car?
Yes, you can use cash to buy a car from a dealer or an individual. You can pay with physical cash, a cashier’s check, a personal check or a wire transfer.
What is the best way to pay for a car?
The best way to pay for a car is with cash, without taking out any kind of loan, because you’ll avoid paying interest. But if you don’t have enough money to pay for your car outright, an auto loan is usually the next best option given that it will likely have a lower interest rate than a personal loan.
What expenses should I keep in mind when budgeting to buy a car?
When you buy a car, you’ll also have to pay for sales tax, car registration, document fees, title fees, emissions inspections and dealer fees, depending on what state you buy your car in. Keep these expenses in mind as you create your budget.
Bottom line
Both personal and auto loans can be good options for purchasing a car. Unsecured personal loans offer flexibility and immediate ownership of the car, but they usually have higher interest rates. Auto loans, on the other hand, are secured by the car and have lower interest rates while being accessible to buyers with low credit scores.
The decision boils down to your credit profile, financial priorities and risk tolerance. Evaluate your financial standing and needs, and choose the loan that aligns best with your situation.
Article sources
- Pentagon Federal Credit Union, “ Your Personal Loan Questions Answered .” Accessed Aug. 17, 2023.
- Atlantic Financial Federal Credit Union, “ Requirements for a Personal Loan .” Accessed Aug. 17, 2023.
- Federal Reserve Bank of St. Louis, “ Finance Rate on Personal Loans at Commercial Banks, 24 Month Loan .” Accessed Aug. 29, 2023.
- Credit Union of Southern California, “ How Long Does It Take To Get A Personal Loan? ” Accessed Aug. 17, 2023.
- T&I Credit Union, “ Vehicle Loans .” Accessed Aug. 17, 2023.
- Statista, “ Interest rates on 60-month new car loans in the United States from February 2014 to August 2023 .” Accessed Aug. 29, 2023.
- Motor1.com, “ Average Car Loan Interest Rates .” Accessed Aug. 29, 2023.
- Equifax, “ How Big Should My Car Down Payment Be? ” Accessed Aug. 29, 2023.
- Greater Texas Credit Union, “ How Long Are Auto Loans? Understanding Car Loan Length .” Accessed Aug. 17, 2023.
- Credit Union of Southern California, “ What Credit Score is Needed to Buy a Car? ” Accessed Aug. 17, 2023.
- Navy Federal Credit Union, “ Auto Loan Preapproval Process .” Accessed Aug. 17, 2023.
