Many car buyers rely on loans to finance their new vehicle, and many use auto loans—but you can use a personal loan to buy a car, too. After all, buying a car is expensive. If you don’t have enough cash on hand to buy a new car or one that’s new to you, you need a loan.
There are some key differences between auto loans and personal loans. Which type of loan is better for you will depend on your specific situation. So even if it made sense for your friend to use a car loan, it might make more sense for you to use a personal loan to buy a car.
Buying a car is one of the biggest purchases many people will make. With the average price of a new vehicle around $47,000 in 2022, most people need to finance their car purchase through an auto loan. However, some may consider using a personal loan instead. In this article, we’ll examine the pros and cons of using a personal loan to buy a car so you can decide if it’s the right choice for your situation.
What is a Personal Loan?
A personal loan is an installment loan from a bank, credit union, or online lender that can be used for any purpose. Personal loans are unsecured, meaning they don’t require collateral like your home or car.
Personal loans have fixed interest rates, terms of 1-7 years typically and predictable monthly payments. You receive the loan amount upfront in a lump sum and make payments until it’s fully repaid. The loan amount, interest rate fees, and term length depend on factors like your income, credit score, and debt-to-income ratio.
When Does it Make Sense to Use a Personal Loan for a Car?
In most cases, an auto loan is the better option for financing a car purchase because of the lower interest rates. However, there are some situations where using a personal loan could be advantageous
Buying from a Private Seller
Auto loans require you to purchase from a dealership. With a personal loan, you can buy from a private seller.
Older Vehicles
Most lenders limit auto loans to vehicles under 10 years old. A personal loan provides more flexibility for older cars.
Lower Credit Scores
Personal loans may be available if your credit score is too low for most auto loans. However, interest rates will likely be much higher.
No Down Payment
Auto loans often require 10-20% down. With a personal loan, you can get financing with $0 down.
Shorter Term Loans
If you want a 12-24 month loan to pay off quickly, personal loans offer shorter terms than most auto loans.
In my opinion, using a personal loan only makes sense for these specific situations. Otherwise, an auto loan is the better choice.
Pros of Using a Personal Loan for a Car
Let’s look at the potential benefits of using a personal loan to finance your next car:
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Faster application process – You can apply for a personal loan entirely online and get a decision within minutes or hours. Auto loans can take days for approval.
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No collateral required – Personal loans are unsecured so your car isn’t at risk if you default. The lender can’t repossess it.
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Fixed interest rates – Personal loan rates are fixed so your monthly payment won’t fluctuate. Auto loan rates can be fixed or variable.
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Predictable payments – Personal loan payments are the same each month over the loan term so it’s easy to budget.
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Shorter terms available – You can choose a 12, 24, 36 month personal loan to pay off faster. Auto loans are usually 48-72 months.
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May help credit scores – Making on-time payments can improve your credit. Personal loans increase your total accounts and credit mix.
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Buy from private sellers – Personal loans allow you to buy a car from an individual seller, not just dealers.
For the right borrower, a personal loan can provide an easy and fast financing option for a car purchase.
Cons of Using a Personal Loan for a Car
However, there are also some downsides to be aware of:
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Higher interest rates – Personal loans have higher rates, often over 10% APR for good credit. Auto loan rates can be under 5% for excellent credit.
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Shorter terms mean higher payments – Even if you qualify for a low rate, shorter loan terms equate to higher monthly payments.
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Prepayment penalties – Some personal loans charge a penalty fee if you pay off early. Auto loans don’t have prepayment penalties.
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May require lump-sum payment – Personal loans provide the full amount upfront. You’ll need to make a lump-sum payment to the seller.
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Harder to qualify – Personal loans have stricter credit requirements than auto loans. Your credit score needs to be in good shape.
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Not available for bad credit – Borrowers with credit scores below 580 will likely not qualify for a personal loan. Subprime auto loans are an option.
While personal loans have their perks, the cons above make them impractical for most car buyers. Make sure to weigh them carefully when deciding.
What is an Auto Loan?
Since an auto loan is usually the better option, let’s review what an auto loan is quickly:
An auto loan is a secured installment loan used specifically to finance the purchase of a car from a dealership or private party seller. They require the vehicle as collateral in case of default.
Auto loans have lower interest rates than personal loans, ranging from 3-10% for prime borrowers. Auto loans also have longer repayment terms of 24-84 months typically.
The lender provides the loan amount directly to the dealership or seller. You then make monthly payments over the loan term until it’s paid off.
How Much Can You Borrow for a Car with a Personal Loan?
Personal loan amounts range from $1,000 up to $100,000 usually. How much you can qualify to borrow depends on factors like:
- Income – Lenders want to see you have enough income to afford the monthly payments.
- Credit score – Borrowers with higher scores can qualify for larger loan amounts.
- Debt-to-income ratio – Lenders limit the amount of your gross monthly income that can go toward debt payments, often at 50%.
- Loan purpose – Lenders may limit loan amounts for car purchases to the value of the vehicle.
When applying for a personal loan, it’s best to only borrow exactly what you need. Don’t take out extra money you won’t use since it will cost you more in interest charges over the loan term.
What Credit Score is Needed for a Personal Loan?
To qualify for a personal loan, you’ll generally need good to excellent credit, defined as:
- Good credit – Scores of 670-739
- Very good credit – Scores of 740-799
- Excellent credit – Scores of 800-850
Lenders have minimum credit scores:
- Online lenders often require a 640 FICO score or higher.
- Banks typically require 660+ score.
- Credit unions may go a bit lower, with minimums around 600.
While you can qualify for personal loans with fair credit in the 580-669 range, interest rates will be much higher – often over 20% APR.
Before applying, check your credit reports and FICO score so you know where you stand. This will allow you to pick lenders you’re likely to qualify with.
What is the Process to Apply for a Personal Loan?
The process to apply for and receive funds from a personal loan takes about 1-2 weeks usually. Here are the basic steps:
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Pre-qualify – Complete a soft credit check form online to see estimated rates and loan amounts you may qualify for. This doesn’t impact your credit score.
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Compare loan offers – Evaluate loan offers from multiple lenders. Compare interest rates, fees, terms, and eligibility requirements.
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Apply – Select your top choice lender and complete the full application with personal and income details. This includes a hard credit check.
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Get approved – The lender will review your application and make a credit decision within 1-3 days typically. You’ll receive a loan offer if approved.
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Accept loan terms – Review the final loan agreement thoroughly and make sure you understand and agree to the terms before signing.
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Receive loan funds – Once approved and documents signed, the lender will disburse the loan amount directly into your bank account, usually within 1-7 days.
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Begin repayment – Your first monthly payment will be due 30-45 days after getting the funds. Set up autopay through your bank for convenience.
Be sure to carefully consider if a personal loan fits your budget and repayment ability before applying. Shop around with multiple lenders to secure the best rate possible.
What Interest Rates Can You Expect with a Personal Loan?
Personal loan interest rates currently range from about 6% to 36% overall. The rate you qualify for depends on your credit profile:
| Credit Score | APR Range |
|---|---|
| 750-850 | 4.99%-15.99% |
| 700-749 | 5.99%-18.99% |
| 650-699 | 9.95%-24.99% |
| 600-649 | 15.99%-29.99% |
| 580-599 | 19.99%-35.99% |
In addition to your credit, the lender, loan amount, term length, income, and other factors determine your rate. Rates are always higher for bad credit borrowers.
Compare
How do I get an auto loan to buy a car?
Some buyers find it convenient to work with the auto dealer on financing. Those types of loans are indirect auto loans, because the loan is obtained through the dealer in partnership with the lender.
A borrower can use an auto loan only to buy a specific vehicle. Unlike unsecured personal loans, car loans are always secured. The car you buy is the collateral. This is one reason that auto loans usually come with lower interest rates than personal loans. The downside is that if you default on the loan the auto lender will repossess your car.
When financing through the dealer, you apply for an auto loan at the car dealer as you are buying your car. Car dealers often try to get buyers to focus on the monthly payment. Then they combine the trade-in value, sale price of the vehicle, add-ons like special car mats and features packages, and the loan. They can stretch out the term of the loan to get you the monthly payment you want, but at a greater overall expense to you. Some lenders offer secured auto loans directly to the borrower, also known as direct auto loans. Similar to indirect auto loans, the vehicle will be collateral for the loan. The main difference between an indirect and direct auto loan is the borrower is not limited to a particular dealership when using a direct auto loan. They can go to any dealership of their choice and know their buying power prior to shopping for a new vehicle.
On the positive side, you might obtain as big a loan as you need to buy the car. And dealer financing offers qualified buyers the option of stretching out the loan over time so they can lower their monthly payments. Also, auto lenders sometimes offer special financing deals, especially to people with excellent credit scores.
TD Bank doesn’t offer dedicated auto loans that are direct to consumers and secured by the vehicle, although TD Bank does do indirect auto financing through dealerships.
How do I use a personal loan to buy a car?
You can use a personal loan to buy just about anything, including a car. They give a borrower a lot of flexibility. With a personal loan, youre not tied to the purchase of a specific car. You can apply for a loan based on your target price as you begin the hunt for the perfect car. With a personal loan, youre free to buy a car from anyone you like—whether it’s a car dealer, an auto auction or a private seller. Youre also free to shop around for the best interest rates and loan terms rather than being tied into the terms offered by a dealership.
A personal loan can give you more control over how you spend the money. For example, if you find a car that costs less than the amount of your personal loan, you are free to spend anything left over on something else. You could use it to pay off high-interest-rate credit card debt or use it to pay for your car insurance. You could also pay it back into your personal loan which may reduce the amount of interest you pay overall. The process of getting a personal loan is the same regardless of what you plan to use it for. At TD Bank, you can see your personal loan rate options and apply online.
Why Getting a Car Loan Is a Bad Idea
FAQ
Should you take out a personal loan to buy a car?
Is it cheaper to get a car loan or personal loan?
Can I loan myself money to buy a car?
What kind of loan is best to buy a car?
Can I use a personal loan to buy a car?
If you’re buying a car from a private party, you may need to consider a personal loan from a bank, credit union, or online lender. While banks offer auto-specific loans, purchasing a car from an individual requires a patient seller willing to jump through some hoops.
Is a personal loan better than an auto loan?
Funds from a personal loan can be more flexible than funds from an auto loan — they can be used not just for purchasing a car but for the other costs of owning a car as well. Personal loans can be secured or unsecured, with either fixed or variable interest rates.
Can I use an unsecured personal loan to buy a car?
An unsecured personal loan can be used to buy a car, but it will typically cost more than an auto loan in most cases.
Should you use a traditional auto loan to finance a car?
You’re almost always better off using a traditional auto loan to finance a vehicle. Personal loans can be used for anything, including making a car purchase. However, using a personal loan for a car may not be the most cost-effective option.