Personal Loan Vs. Auto Loan: Which One Should You Use?

If you’re interested in buying a car, be prepared to make a few important decisions before driving off the lot. Will it be a new or used car? What make and model do you prefer? And most importantly, how will you pay for it?

As new and used vehicle prices remain historically high, it’s important to consider your options for financing this substantial purchase. While it might be natural to pursue an auto loan, a personal loan could be a better fit for your financial situation.

Let’s review the differences between personal loans and auto loans so you can decide which option is right for you.

Before we delve into how you can use a personal loan or auto loan (also known as a car loan) to finance an auto purchase, let’s examine how both loan options work.

What Is An Auto Loan?

An auto loan is a type of secured loan that requires a borrower to use their car as collateral. Since the loan is secured against the car, an auto loan is usually easier to qualify for and has a lower interest rate. However, qualification requirements and interest rates vary by lender.

If you’re thinking of applying for an auto loan, make sure you have enough saved for a down payment. It’s possible in some cases to secure an auto loan with no down payment, but you’re more likely to get stuck paying a higher interest rate.

Auto loans can also be tricky because most lenders will only approve funding for certain types of cars or model years. So while your lender might be happy to lend you the money to purchase a new car, they may not approve a loan for a decades-old fixer-upper.

What Is A Personal Loan?

A personal loan is a type of credit that allows you to borrow a predetermined amount of money from a bank, online lender or credit union. Although collateral-requiring secured personal loans are an option, unsecured personal loans – which come with a fixed interest rate, a set amount of time to repay the loan, and no collateral requirement – are more common.

Personal loans are known for their flexibility, meaning they can serve a variety of purposes. Some of the most popular uses ofpersonal loans are home improvement projects, debt consolidation and large purchases.

While you don’t need to make a down payment on a personal loan, your lender may charge an origination fee. Once you’re approved for a personal loan, you’ll begin making payments on it every month until the loan is paid back in full, which is why it’s vital to ensure that you can commit to the established payment schedule.

Yes, you can! As stated above, you can use a personal loan to purchase pretty much anything within reason. In fact, using a personal loan to buy a car can be more beneficial than using an auto loan in situations such as one where you’re purchasing an older model for collecting or restoration. Personal loan lenders typically don’t place restrictions on how you can use your loan, so car purchases are fair game.

One factor to consider, however, is pricing. Most personal loan amounts range from $1,000 to $50,000, although they can go up to $100,000 in rare instances. Depending on the amount of your personal loan, you shouldn’t have any problem purchasing a vehicle priced at $50,000 or less, but anything more expensive will require you to pay the difference out of pocket.

Keep in mind, too, that a lender may charge a higher interest rate for a larger loan amount.

This chart provides an overview of the differences between personal and auto loans. You can find more in-depth information further down in the article. 

While you can use a personal loan for a car purchase, it’s best to weigh your options against an auto loan. Let’s take a look at the factors you should consider when deciding whether to use a personal loan to purchase a car.

Pros Of Using A Personal Loan For A Car

• No down payment: Personal loans don’t require borrowers to pony up a down payment, which is especially helpful when you need money in a pinch. This feature is attractive to car buyers who would otherwise be required to put a down payment on an auto loan.
• No car restrictions: Once the money is in your account, you can spend the loan amount on any car make, model or typeyou want. Unlike some auto loans, personal loans don’t have restrictions that dictate the type of car you can purchase.
• No chance of car repossession: If you purchase a car using an unsecured personal loan, you aren’t required to use the car as collateral. This means that even if you default on the loan, the lender can’t repossess your car, although you will face other consequences from the lender.

Cons Of Using A Personal Loan For A Car

• Higher interest rates: Compared to an auto loan, a personal loan usually has a higher interest rate, assuming it’s unsecured. Ultimately, you can pay much more for a shorter-term personal loan than a longer-term auto loan.
• More qualification restrictions: To qualify for a personal loan, lenders will evaluate your credit score and credit history, income, debt-to-income ratio (DTI), savings amount and employment history. These restrictions make it more difficult for people with bad credit or high levels of debt to obtain a personal loan.
• Additional loan fees: As mentioned above, many lenders tack additional fees onto a personal loan. Origination fees can range from 1% – 10% of the total loan amount, possibly requiring borrowers to increase their loan amount to cover the cost.

With personal loans having higher interest rates and stricter credit requirements, it may seem to make more sense to finance your car purchase with an auto loan. However, it’s still important to understand the benefits and drawbacks of this loan option. Let’s review the factors you should consider when deciding whether to take out an auto loan.

Pros Of Using An Auto Loan To Buy A Car

• Affordability: If you need a loan to cover your next car purchase, an auto loan will typically be your least expensive option. Given the likelihood of lower monthly payments and long-term interest savings, this loan option is generally more affordable.
• Less restrictive qualifications: Since the loan lender’s investment is protected by the collateral requirements of the auto loan, the lender may be more lenient with their credit requirements. Although it helps to borrow with a higher credit score, it’s still possible to get an auto loan with a less-than-perfect credit history.
• Availability through dealerships: Along with being offered by traditional loan lenders, auto loans can also be available through the car dealership selling your prospective vehicle. Pro tip: Bring prequalified offers from other lenders to the dealership to negotiate an even better deal.

Cons Of Using An Auto Loan To Buy A Car

• The likelihood of a down payment: A major drawback of auto loans is the down payment that most lenders require. However, the larger the down payment, the shorter the loan term and, in some cases, the lower the interest rate.
• Risk of car repossession: When you use your car as collateral on an auto loan, you run the risk of losing the car through repossession in the event of a loan default. While this might sound a little scary, it’s important to keep in mind that using the car as collateral allows a borrower to secure more favorable loan terms.
• Car restrictions: Some auto loans require that the car you’re purchasing not be so old – and that the car be in working condition. In light of these restrictions, you might not be able to use a car loan to buy a vintage model.

Ultimately, the decision for financing comes down to your situation and what works best for you.

Using a personal loan to buy a car can make sense if:

• You have good or excellent credit
• You don’t have the money for a down payment
• You’re buying an older car model

An auto loan is likely a better option if:

• You have a more moderate credit score or DTI
• You’re buying a new car from a dealership
• You need a larger loan amount for a vehicle

Whether you’re planning to apply for a personal or auto loan, there are several steps to take before signing on the dotted line. Here’s how to get a personal loan or an auto loan:

1. Secure your credit report. Since you’ll be using your credit and financial information to apply for a loan, it’s a good idea to double-check its accuracy. Checking your credit score beforehand can also help you gauge the interest rate that your loan lender will offer.
2. Shop around for lenders. Once you’ve decided on the kind of loan to pursue, shop around various lenders for the best interest rate and other loan terms to find the sweetest deal.
3. Apply for prequalification. The prequalification step allows you to preview the lender’s loan amount and terms for you, without affecting your credit score. Some auto loan lenders offer preapproval, but keep in mind that your credit history will reflect a hard credit inquiry.

If you’re debating between purchasing a car using a personal loan versus an auto loan, keep your budget and priorities top of mind.

Auto loans can be a more affordable way to pay for a new or used car, but most auto loans will require a down payment at signing. On the other hand, personal loans for cars may be the preferred option for borrowers who don’t have down payment funds ready or don’t want to use their car as collateral for the loan.

If you’re ready to explore your personal loan options, get the application process started today with Rocket Loans℠.