Key learning points
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A personal loan can be a good idea to finance a used car if conventional financing is not available or if you do not qualify for a car loan.
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Rates can be higher and repayment terms shorter, compared to traditional auto loans.
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You may be able to avoid having your vehicle repossessed if you default on a personal loan repayment.
Unless you can pay cash, you’ll likely need to finance a vehicle. Most buyers do that. However, a car loan is not your only option.
Personal loans can be used for almost any purpose, including buying a car. Depending on the circumstances, it may even make more sense than taking out a car loan. That said, there are a few drawbacks you should consider before choosing this option.
When do you use a personal loan for a used car or new car?
A personal loan is not the first thought of most buyers, but it can be useful in certain scenarios.
1. No conventional financing is available for the vehicle
If you’re considering buying an older car, it may not always be possible to secure conventional car financing. Some lenders may refuse to finance a vehicle that is more than 10 years old. Lenders may also require vehicles to have less than 100,000 miles.
2. Your credit isn’t good enough for a car loan
If you have less than ideal credit, it can be difficult to get a car loan. In some cases, you may only qualify for financing on a buy-here-pay lot, which can be extremely expensive.
Borrowers with a subprime credit score pay the highest interest rates. The average interest rate on a subprime car loan during the fourth quarter of 2023 was 18.89 percent for used cars and 12.28 percent for new cars, according to Experian.
Subprime lenders should only be considered if you have no other options available. Taking out a personal loan can be a better alternative. Some lenders even offer bad credit loans, which can result in a more competitive offering due to more flexible credit requirements.
However, it’s worth noting that personal loan rates for bad credit also tend to be high. Borrowers with FICO scores between 630 and 689 receive average personal loan interest rates between 17.80 percent and 19.90 percent.
Before submitting a formal application, consider prequalifying for a loan with at least three lenders. This allows you to compare real offers side by side and decide whether a personal loan is the best route, without impacting your credit rating.
3. Your personal loan interest rate is lower than that of a car loan
Interest rates for unsecured personal loans are typically higher than interest rates for car loans. But if you have outstanding credit, you may qualify for a competitive interest rate offer. Some personal loans have a starting interest rate of only 7.49 percent. That’s lower than the average superprime rate for a used car loan, which is 7.66 percent.
However, if you qualify for a low-interest personal loan, you may also qualify for special auto loans. This could mean a significant discount or even zero percent financing on your car loan. So make sure you look at both options to see which would be the smarter financial choice.
Using a personal loan versus using a car loan to buy a car
Car loans and personal loans are similar in that they are both installment loans. This means that you pay monthly for a certain period. They both have a fixed interest rate.
Your income and credit history are critical to getting approved for either type, but there are also some important differences.
| Personal loan | Car loan |
|---|---|
| Can be secured or unsecured | Secured |
| Can be used for multiple purposes | Limited to vehicle financing |
| Usually higher interest rates and shorter loan terms | Lower interest rates and longer loan terms |
Use a personal loan
Personal loans can be used to cover the costs of various financial needs, from medical expenses to the cost of a wedding or debt consolidation and yes, the purchase of a car.
However, most personal loans are unsecured, meaning they do not require collateral. Because the loan is riskier for the lender, the interest on a personal loan is usually higher.
In addition, the repayment period may be shorter. Most lenders limit loan terms to five years.
Take advantage of a car loan
A car loan is a secured loan specifically designed for purchasing a vehicle. The vehicle is collateral. This means that the car can be repossessed if the loan becomes delinquent or if you default.
Due to the lower risk, lenders typically offer more favorable interest rates and terms for these loans. They can also offer loan terms of up to seven years, which means a smaller monthly payment.
Pros and cons of using a personal loan to buy a car
While personal loans can be a good alternative to financing a car, they may not be the right option for you. When making a choice, consider the following factors.
Positives
- Quick access to cash
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Some lenders offer next day and even same day financing. This can be useful if you want to use the loan to buy a car from a private seller, as it will allow you to take action more quickly.
- No deposit
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While a down payment is not always required to get a car loan, it is often encouraged to help you get a lower interest rate. By using a personal loan you avoid having to put down 10 to 20 percent of the car’s purchase price to get a better loan.
- No collateral
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While some personal loans are secured, many are not. If you have good credit, you may qualify for an affordable unsecured loan. You won’t be risking your car if you can’t pay, although the lender can still sue you if you default.
Cons
- Higher interest rates
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Because there is no collateral to reassure the lender, the average interest rate on personal loans is higher than the average interest rate on car loans. Rates can be as high as 36 percent, although these rates are not unheard of for bad credit car loans.
- Higher monthly costs
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Personal loans typically have higher rates and shorter repayment terms. This means that you can get a higher monthly payment than if you took out a car loan.
- Limited amounts
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Personal loan providers tend to limit loan amounts and terms based on creditworthiness. If you have bad credit, you may not be able to get a loan high enough to cover the full cost of your desired vehicle.
it comes down to
When buying a used car, a personal loan can sometimes be the best choice instead of a traditional car loan. This is especially true if you can’t qualify for traditional financing or if you want to own your vehicle right away.
However, because these loans are often unsecured, they can come with higher interest rates and shorter repayment terms than many auto loans.
Before making a decision, consider using a loan calculator to crunch the numbers and determine which option makes the most financial sense.
