Auto Loan vs Personal Loan: How to Choose the Best Option for Your Car Purchase

Buying a new or used car is an exciting milestone, but also a major financial investment. With the average new car price exceeding $47,000 in 2022, and used cars costing over $28,000 on average, few buyers can pay cash outright. This leaves financing as the only option for most.

You essentially have two main choices – an auto loan or a personal loan. But how do you decide which is the better fit? In this comprehensive guide we’ll compare auto loans vs. personal loans for financing a car purchase. You’ll learn about

• Key differences between auto loans and personal loans
• Pros and cons of each financing option
• Loan eligibility requirements
• Interest rates, terms, fees, and costs
• How to apply and get approved
• Tips for choosing the best loan for your needs

Follow our in-depth analysis to understand whether an auto loan or personal loan is the smarter way to fund your new set of wheels.

Auto Loan Overview

An auto loan is a secured loan used specifically for financing a car purchase. With an auto loan:

• You borrow a fixed amount based on the car’s price minus any down payment

• The car itself serves as collateral on the loan

• Loans terms are usually 3 to 6 years.

• Interest rates are lower since your car secures the debt.

• Minimum credit scores required are typically lower than personal loans.

• There may be restrictions on the vehicle’s age, mileage, and condition.

Auto loans are offered by banks, credit unions, online lenders, and dealerships. Rates start as low as 3% for buyers with excellent credit.

Personal Loan Overview

A personal loan is an unsecured installment loan that can be used for any purpose. With a personal loan:

• Loan amounts usually range from $1,000 – $100,000.

• Your creditworthiness alone determines if you qualify, not collateral.

• Loan terms are shorter, usually 2 to 5 years.

• Interest rates are higher because they are unsecured.

• Minimum credit scores are higher, often 660+.

• Funds can be spent on any car you want.

Personal loans are offered by banks, credit unions, online lenders, and specialty finance companies. Rates start around 5% for the most creditworthy borrowers.

Key Differences of Auto Loans vs Personal Loans

Here’s a quick rundown of how these financing options differ:

Interest rates – Auto loans have lower rates, while personal loan rates are higher.

Terms – Auto loans can be 3 to 6 years. Personal loans max out at around 5 years usually.

Amounts – Auto loans fund a specific car purchase. Personal loans have fixed limits set by the lender.

Qualifying – Auto loans have lower credit requirements. Personal loans have higher minimum scores.

Collateral – Your new car is collateral for an auto loan. Personal loans are unsecured.

Flexibility – Auto loans can only fund eligible cars. Personal loans can finance any vehicle.

Fees – Auto loans may have prepayment penalties. Personal loans don’t.

As you can see, the options have clear trade-offs to weigh based on your financial situation.

Pros and Cons of Auto Loans

Pros of Auto Loans

• Lower interest rates – Auto loan rates can be 3 to 5 percentage points lower than personal loan rates.

• Pre-approval – You can get pre-approved for a specific loan amount before car shopping.

• Better chances with fair credit – Auto loans may approve borrowers with credit scores in the 600s.

• Potentially no down payment – Some auto lenders approve loans with $0 down for qualifying borrowers.

Cons of Auto Loans

• Vehicle restrictions – Lenders limit loan eligibility by model year, mileage, and condition.

• Required insurance – You must carry comprehensive and collision coverage.

• Collateral risk – Your car can be repossessed if you default on the loan.

• Prepayment penalties – Your loan may charge a fee for paying off early.

Pros and Cons of Personal Loans

Pros of Personal Loans

• Freedom to choose any car – Funds can be used towards any vehicle purchase.

• No prepayment penalties – You can pay off a personal loan early with no fees.

• No collateral at risk – Your car can’t be repossessed for non-payment.

• May offer faster funding – Some personal lenders fund loans within 1-3 business days.

Cons of Personal Loans

• Higher interest rates – Personal loan rates are typically much higher than auto loans.

• Shorter terms – Maximum terms up to 5 years mean higher monthly payments.

• Tough to qualify with fair credit – Minimum scores of 660+ are often required.

• No pre-approval – You must search for a car you can afford within approved loan limits.

As you weigh the pros and cons, consider both costs and risks over the life of the loan.

Auto Loan Interest Rates, Terms & Fees

Auto loan rates and terms vary based on the applicant’s credit profile, income, and expenses. Here’s what to expect:

• Interest rates – For buyers with great credit, rates start as low as 3%. With fair credit expect rates of 10% or higher.

• Loan terms – Repayment terms of 3 to 6 years are typical for auto loans. Longer terms have lower payments but higher interest costs.

• Origination fees – Some lenders charge 1% to 2% of the loan amount in fees. Always ask about fees.

• Down payment – Often 10% to 20% down is required, but $0 down loans are available for qualified applicants.

• Prepayment penalties – Check your loan agreement. Some lenders charge a penalty for paying off your auto loan early.

When reviewing loan offers, crunch the numbers to see both monthly payments and your total repayment costs including interest and fees.

Personal Loan Interest Rates, Terms & Fees

Here are typical costs and terms on personal loans:

• Interest rates – For borrowers with great credit, rates start around 5% to 9%. With fair credit expect 12% or more.

• Loan terms – Personal loan repayment terms range from 2 to 5 years usually. Longer terms mean lower payments.

• Origination fees – Some lenders charge 1% to 8% of the loan amount in origination fees.

• No down payment – Personal loans do not require a down payment in most cases.

• No prepayment penalties – Most personal loans allow you to pay off the balance early with no penalty.

Always ask potential lenders to clearly disclose interest rates, term lengths, origination fees, and any other charges to compare apples-to-apples loan costs.

Auto Loan Eligibility Requirements

Auto lenders evaluate these key factors when you apply for financing:

• Credit score – Minimum scores vary by lender but scores above 620 have the best approval odds. Excellent credit (720+) gets the lowest rates.

• Down payment – Expect a 10% to 20% down payment. Borrowers with great credit may qualify for $0 down.

• Debt-to-income ratio – Your total monthly debt payments divided by gross monthly income. Most lenders require max DTI of 50%.

• Loan term – The longer the term, the more risk for the lender. Terms over 6 years may face greater scrutiny.

• Vehicle age and mileage – Most lenders limit loans to cars 10 years old or newer with under 150,000 miles.

Bringing a higher down payment, keeping your DTI low, and applying with excellent credit scores can help you get approved and get the best auto loan rates.

Personal Loan Eligibility Requirements

Personal loan lenders generally evaluate:

• Credit score – For the best rates, you’ll need excellent credit of 720 or higher. Minimum scores vary by lender but often around 660.

• Income – Most lenders want gross monthly income of at least $2,000 to $4,000 to qualify.

• Debt-to-income ratio – DTI is calculated the same but personal loan lenders often prefer maximum DTI of 40% or less.

• Loan term – Terms of 2 to 5 years are commonly offered. Shorter terms have higher income requirements.

Good credit and sufficient income are key to getting approved for a personal loan and securing the lowest interest rate the lender offers.

How to Apply for an Auto Loan

Follow these steps when applying for auto financing:

1. Check your credit – It’s smart to check your credit scores first so you know where you stand. Sites like Credit Karma offer free score checks.

2. Get pre-approved – Being pre-approved gives you negotiating power and lets you focus your shopping on cars in your approved budget.

3. Estimate your payment – Use an auto loan calculator to estimate what monthly payments you can realistically afford with your income and expenses.

4. Compare lender rates – Check rates from banks, credit unions, and dealerships to find the best deal. Expand your search beyond local lenders.

5. Submit loan application – After choosing a car, complete the full loan application with your preferred lender. This includes pay stubs, W2s, and other required income and identity documentation.

6. Accept your loan terms – Carefully review the loan offer and ensure you understand all costs, fees, and risks before signing the agreement.

Pre-approval takes the stress out of car buying by setting clear budget expectations before you ever step foot in the dealership.

How to Apply for a Personal Loan

Take these steps when seeking personal loan financing:

1. Verify loan amount needed – Determine the total loan amount required based on the car purchase price and any savings you can put down.

2. Check your credit score – Just as with an auto loan, checking your latest credit score helps set expectations before applying.

3. Compare loan options – Research personal lenders like credit unions, banks, and online lenders. Weigh interest rates, fees, terms, and customer service.

4. Prequalify if possible – Some lenders let you prequal