Car Loan vs Personal Loan: Which is Better for Financing a Car?

Buying a new or used car is an exciting experience. However, the costs can quickly add up. Unless you have enough cash on hand, you’ll likely need to finance your vehicle purchase. But should you get a car loan or a personal loan? Here’s a comprehensive guide on the key differences, pros and cons of each type of auto loan to help you make the best choice.

Overview of Car Loans and Personal Loans

A car loan is a type of secured loan specifically for financing a vehicle purchase. The car acts as collateral, so the lender can repossess it if you default. Car loans typically have lower interest rates and may require a down payment.

A personal loan is an unsecured loan that can be used for any purpose. You don’t need collateral and usually don’t need a down payment But interest rates are higher because they are riskier for lenders You can use a personal loan to buy a car if you want.

Interest Rates: Car Loans Are Cheaper

The biggest difference is that car loans have lower interest rates often significantly so. According to the Federal Reserve the average used car loan rate is around 5% APR while the average personal loan rate is close to 10% APR.

This is because car loans are secured by the vehicle so there is less risk to the lender. With personal loans, the lender has no recourse if you stop paying. The higher interest rates on personal loans make them more expensive over the life of the loan.

For example, a $20,000 5-year car loan at 5% APR would have monthly payments of around $377 and total interest paid of $2,335. The same loan amount and term at 10% APR would be $449 per month and total interest of $4,993. That’s more than double the interest charges!

Loan Term Lengths Are Similar

Both car loans and personal loans typically offer terms between 2 and 7 years. Shorter terms mean higher monthly payments but less interest paid over the life of the loan.

Many experts recommend not taking out a car loan longer than 5 years since cars depreciate rapidly. But you may be able to get an 84-month car loan, depending on the lender. Personal loans usually max out at 5 years.

Carefully consider whether you can afford the monthly payments on a longer-term loan. Make sure to calculate the total interest costs as well.

Down Payments Aren’t Always Required

Most lenders require a 10-20% down payment on a car loan, but some don’t. You’ll get a better rate with a down payment since the loan-to-value ratio is lower. With personal loans, you generally don’t need a down payment at all.

If you want to buy a car but don’t have cash saved for a down payment, a personal loan may be your only option. Just be aware you’ll pay a higher interest rate. Saving up even 10% of the purchase price for a down payment on a car loan will lower your rate significantly.

Car Loans Limit Vehicle Types

Car loan lenders often impose limits on the vehicle age, mileage, and condition for a financed vehicle. Most set a maximum age of around 10 years and won’t finance cars with over 100k-125k miles. The car must also be in good working order.

With a personal loan, you can basically buy any type of car you want if the loan amount is approved. This flexibility allows you to purchase an older car, fixer-upper, or specialty vehicle that may not qualify for traditional auto financing.

Car Loans Carry Repossession Risk

Defaulting on a car loan gives the lender the right to repossess your vehicle. With a personal loan, your car isn’t directly tied to the loan so there’s no repossession risk. The lender can still take you to court if you stop paying, but the process takes much longer.

Before taking out a secured auto loan, make sure you can afford the payments. Defaulting and losing your car can severely hurt your credit and finances.

Weighing the Pros and Cons

| Pros of Car Loans | – Lower interest rates save money | – Easier to qualify if credit isn’t great | – Can shop for preferred vehicle |
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| Cons of Car Loans | – Need down payment | – Limits on vehicle age and mileage | – Risk of repossession if default |

| Pros of Personal Loans | – No down payment required | – Can buy any type of vehicle | – Lower repossession risk |
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| Cons of Personal Loans | – Much higher interest rates | – Harder to qualify if credit score is low | – Not tied to a specific car purchase |

How to Choose the Right Loan for You

Here are a few scenarios for when a car loan or personal loan may be the better choice:

• Have good credit and down payment: Car loan. You’ll get the best rates.
• Need $0 down financing: Personal loan. Otherwise tricky to get a car loan with no down payment.
• Buying an older or high mileage car: Personal loan. Most car loans limit vehicle age and mileage.
• Want lower monthly payments: Car loan. The lower APRs result in lower monthly payments.
• Concerned about repossession: Personal loan. Your car isn’t directly tied to the loan.

Whichever option you choose, be sure to shop around and compare multiple lenders. Look for the lowest rates and best terms for your situation. Use auto loan and personal loan calculators to estimate payments. With some planning and smart comparison shopping, you can finance your new car while keeping costs low.