Yes, you can use a personal loan to buy a car, and it could be a good choice in certain scenarios. But auto loans generally offer lower interest rates, making them a better option in most cases.
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 Experians 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. Its 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.
Putting down a sizable down payment when buying a car is always a smart move. It lowers your monthly payments, interest costs and chances of being upside down on your loan. But coming up with a 20% down payment on a $40000 vehicle means saving up $8000 or more. That’s no small feat.
So what if you want or need a different car now but don’t have enough saved? You might consider taking out a personal loan for the down payment. This can help you get the car you want while building your credit. But it also comes with risks, like higher monthly payments. Here’s what to know before getting a personal loan for a car down payment.
How Much Down Payment Do You Need?
Experts recommend putting down at least 20% on a new car and 10% on a used model. With the average new car price around $47,000 in early 2023, that’s $9,400 down. For used cars averaging $28,000, plan on $2,800 down.
Putting extra down is always better to reduce interest costs and avoid owing more than the car is worth. But not everyone can swing 20% down, especially first-time buyers. In that case, put down as much as you can. Even 5% or 10% helps lower your payment.
Run any potential down payment through an auto loan calculator to see the payment impact. If you put $2,000 down on a $30,000 loan at 4% interest over 60 months, you’ll pay around $495 a month. Up that to $4,000 down, and your payment drops to about $455.
Can You Use a Personal Loan for a Down Payment?
Yes, you can use a personal loan to fund a car down payment Personal loans are installment loans you pay back monthly over 2 to 7 years usually They tend to have lower rates than credit cards, making them a less expensive way to borrow.
Lenders like banks, credit unions and online lenders offer personal loans from $1,000 up to $100,000. Rates range from about 5% to 36%. Your credit, income, existing debts and the lender you use all impact the rate you’ll pay.
Taking out a $5,000 personal loan at 10% interest over 5 years would cost about $105 in monthly payments. You’d pay roughly $1,300 in interest over the life of the loan.
Pros of Using a Personal Loan for a Down Payment
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Fast funding. You can often get funds in a week or less after approval. This allows you to buy on your timeline.
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Fixed rates. A personal loan locks in an interest rate for the entire repayment term. You don’t have to worry about rates going up down the road.
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Simple applications. Many lenders let you prequalify and apply entirely online with a soft credit check.
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Build credit. Making on-time payments helps build your credit history and scores. This could help with future car loans.
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Lower rates than cards. Average credit card interest tops 19%, per Federal Reserve data. Personal loans can offer single-digit rates to borrowers with good credit.
Cons of Using a Personal Loan for a Down Payment
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Higher monthly payments. You’ll need to budget for the car payment plus the personal loan payment each month. personal loan payment each month.
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Paying more interest. Interest charges add to the overall cost. Pay off the loan as fast as possible to limit interest.
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Risk of accelerated depreciation. If you total the car soon after buying, insurance payouts may not cover both loan balances. Gap insurance helps here.
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Potential credit impacts. Lenders may see the new debt-to-income ratio as too high. Hard checks lower scores temporarily.
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Prepayment penalties. Your loan may charge a fee if you pay off early. But many personal loans don’t have prepayment penalties.
Alternatives to Personal Loans for Down Payments
Here are a few other options if you need money for a down payment:
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Use savings. Even if it takes a few more months, avoiding debt is ideal. Make a budget to boost savings faster.
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Borrow from family. Ask a relative for a down payment loan. Offer to sign a contract detailing repayment terms.
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Take out a 401(k) loan. You borrow against your own contributions. But if you leave your job, the loan could default and face penalties.
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Use credit card rewards. Cash out points from travel cards to pay the dealer directly. This avoids interest.
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Sell assets. Old cars, collectibles, unwanted jewelry or other items could net extra down payment cash.
What Lenders Check When Using a Personal Loan for a Down Payment
When you apply for the auto loan, the lender will pull your credit reports and see the new personal loan. This gives them a fuller picture of your debts.
Here are two key factors they consider:
Debt-to-income ratio: Your total monthly debts divided by gross monthly income. Most auto lenders want this below 15% or 20%. The personal loan raises your ratio.
Auto loan-to-value ratio: The size of your requested auto loan versus the car’s value. Lenders get nervous above 110% to 120% loan-to-value. Large down payments keep you within safer ratios.
If the lender thinks you’re overextended, they may deny the application. Or they could approve you but with a higher rate. This makes the loan costlier.
Tips for Getting Approved
If you use a personal loan for the down payment, getting approved for the auto loan itself can be trickier. Here are tips that can help:
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Shop around to find the best auto loan rates for your situation. Comparison shopping avoids taking the first subpar offer.
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Get prequalified before you shop. This shows the dealer you’re a serious buyer who’s ready to buy.
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Boost your credit score. Making payments on time and lowering debts can help your case.
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Ask for co-signers. A cosigner with better credit means you’re more likely to get approved and get lower rates.
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Bring proof of future income. If you have a new job lined up, share the offer letter and start date.
The Bottom Line
A personal loan can be a relatively fast, affordable way to get cash for a car down payment compared to options like credit cards. Just carefully consider the costs and make sure your income can support the additional monthly payment. Shop around for the best rates and terms on both the personal loan and auto loan.
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 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 dont 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 isnt 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 cant 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.
How To Get Your First Auto Loan With No Down Payment
FAQ
Can you use a personal loan as a downpayment for a car?
Can I borrow money for a down payment on a car?
Can I take a personal loan for downpayment?
Is it smart to use a personal loan to buy a car?
Do all auto loans require a down payment?
Not all auto loans require a down payment, though many do. A large down payment might also unlock lower interest rates, and it can help you avoid becoming upside-down in your auto loan. Personal loans don’t require (and aren’t affected by) down payments. Personal loans can be secured by collateral, but they typically aren’t.
How much does a down payment affect a car loan?
Putting more down reduces the amount you’ll need to finance and helps you to pay the loan off sooner. As a general rule, every $1,000 in the down payment reduces your monthly payment by $15 to $18. You can use our auto loan calculator to see how various down payment amounts will affect your monthly payments.
Do you need a down payment when buying a car?
You should always have a down payment when buying a car. Some experts say it might not be necessary if you’re able to score 0 percent APR — but most people won’t qualify for that. You may not need a down payment for a leased car, either. It can still help lower your monthly payment and overall cost.
Do personal loans require a down payment?
Personal loans don’t require (and aren’t affected by) down payments. Personal loans can be secured by collateral, but they typically aren’t. This means your car is not at risk if you default on your loan.