Personal Loans Vs. Auto Loans: What Are Their Differences?
Personal loans and auto loans are common choices for those interested in buying a new or used car. If you’re in the market for a new vehicle, you’ll need to decide on the best car financing option for your situation.
There are advantages and disadvantages to both these loan options. Let’s look at the key differences and the pros and cons of each loan so you can choose what’s right for you.
What’s The Difference Between An Auto Loan And A Personal Loan?
While there are many differences between a personal loan and an auto loan, perhaps the most important difference is that a personal loan can be used for anything, while an auto loan can only finance a vehicle purchase. Another important difference is that an auto loan is a secured loan, while most personal loans are unsecured.
Let’s take a look at the main aspects of these loans and how they differ.
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Personal Loans Vs. Auto Loans
| Personal Loans | Auto Loans |
|---|---|---|
Loan Type | Unsecured or secured | Secured by your vehicle |
Down Payment | Not required | Typically required at signing |
Interest Rates | 3% – 36% | 4.75% – 20.62% |
Car Type | No limitations | New and used cars – limits on cars older than 10 years |
Loan Length | Typically 2 – 7 years | Typically 1 – 8 years |
Loan Type
Personal loans are generally unsecured loans, meaning your credit score and income determine whether you qualify. Though some lenders offer secured personal loans, they aren’t as common. Unsecured personal loans generally have higher interest rates. That said, if you default on a personal loan, it’s less likely to result in your car being repossessed.
Auto loans are secured loans, which means your car acts as collateral for the loan. Though this may mean lower interest rates, there is a higher risk of car repossession if you miss payments and default on your loan. While a lender may seize your car if you default on a personal loan, it would have to go through the court system first.
Interest Rates
Although interest rates vary for both loans, car loans are secured loans, which means they’ll generally have lower interest rates. On the other hand, personal loans generally have higher rates. That means the rate you qualify for can vary based on your credit score, debt-to-income ratio (DTI) and annual income.
Even though auto loan rates are generally lower, the rate you receive will depend on a few factors. Your credit score will influence the rate you qualify for, so you can still save money if you have good to excellent credit. Your loan-to-value ratio (LTV), which can also help you save money, is the total dollar amount of your loan divided by the actual cash value of your car. Several factors can influence your LTV ratio, including your down payment.
Car Type
Auto financing limits the type of car you can buy. New cars and used cars less than 10 years old are usually financed at a dealership or directly through a credit union, bank or other financial institution.
Personal loans, on the other hand, are much more flexible around the type of car you buy because you can use the cash from a personal loan for almost anything. With a personal loan, you can purchase any car type you like. The loan can simplify buying a car directly from an individual or even help you buy a vintage car at an auction. Personal loans can also be simpler to secure, and you can qualify for one online.
Down Payment
You’ll likely need to make a down payment with a car loan. Some dealers may require zero down on new or used cars, but it may result in a higher interest rate. Though down payments are often flexible, you’ll usually get a better interest rate if you put down 20% of the car’s cost at signing.
Personal loans don’t require any down payment. You apply for the loan and receive a single lump-sum payment from your lender. However, your lender may require an origination fee, which helps cover the administrative costs of creating your loan.
Loan Length
For both personal loans and car loans, repayment term lengths are often extremely flexible and depend on the lender and your needs. While longer car loans have grown in popularity in recent years, the most common loan lengths are 60 or 72 months. Some car loans can even last as long as 96 months.
Like car loans, personal loans are highly customizable to your needs. For most borrowers, loan terms that last 2 – 7 years are typical, though many lenders offer longer-term loans. Keep in mind that the length of your loan affects the overall amount of interest you pay. A longer loan means more money spent on interest over time.
Personal Loan Vs. Auto Loan: Pros And Cons
There is a lot to consider between the two types of loans to finance your car purchase. Let’s take a look at some pros and cons of an auto loan versus a personal loan to help you decide:
Personal Loan Pros
- No limits on the type of car you can buy
- Lower risk of repossession
- Easy to buy directly from private car owners
- No down payment requirement
Personal Loan Cons
- Potentially higher interest rates, especially for borrowers with poor credit
- Can be harder to qualify for
Car Loan Pros
- Generally lower interest rates
- Easier to qualify for because of collateral
- Can help build your credit score
Car Loan Cons
- Requires a down payment
- Typically requires proof of car insurance
- Limits the type of car you can buy
- Higher risk of repossession
When Should You Use A Car Loan Or A Personal Loan?
Now that you have an idea of the advantages and disadvantages of both types of financing, you might be wondering which option is best for you. To help you decide, you should assess your situation and ask yourself these questions:
- What type of car am I buying? If you plan on buying a car less than 10 years old, a car loan will probably be the best choice. A personal loan might be a better choice if you’re interested in a classic car over 10 years old.
- What is my credit score? Since personal loans can have stricter eligibility requirements than auto loans, a car loan could offer a lower interest rate if you have poor credit.
- Do I have the funds for a down payment? Car loans require a down payment, and personal loans don’t. If you can’t afford a down payment, a personal loan can help you buy a car without putting money down.
The Bottom Line
Buying a car is a big step. Deciding whether to use an auto loan or a personal loan to finance your vehicle will ultimately be based on your situation.
If you have enough money saved for a sizable down payment and are willing to accept some risks associated with an auto loan in exchange for a lower interest rate – an auto loan may be the best choice for you.
If you’re looking for a bit more flexibility around the type of car you buy or can’t afford to make a down payment right now, a personal loan may be the better choice.
