Most car shoppers assume there are only two ways to buy a car - take out an auto loan or purchase the vehicle in cash (a less common choice). However, there is a lesser-known option for financing a car purchase which is to take out a personal loan. Although most commonly associated with emergency expenses or debt consolidation, a 'personal' loan means that the borrower can use the funds for anything he or she wants. While it's possible to purchase a car with a personal loan, it isn't the best choice for everyone. We break down the benefits and risks of personal loans to help you decide on the best financing route for your car.
Benefits of Personal Loans
Personal loans come in two forms: secured and unsecured. A secured loan means the lender holds collateral until the loan is paid off, and unsecured means the borrower gets the funds without any collateral at stake. Most personal loans are unsecured, so in the case of a car purchase, the car will not be at risk of repossession if the borrower fails to repay the loan. Although this seems like a great deal for the car shopper, it comes with some drawbacks.
Along with the peace of mind of avoiding vehicle repossession with an unsecured personal loan, another benefit of using a personal loan for a car purchase is flexibility. Because the funds can be used for anything, there are no restrictions for the type of vehicle you can buy. This means you can purchase anything from a brand new model to a used classic car.
When taking out a car loan, most lenders will need to know exactly which vehicle you will buy so they can issue the right loan amount, but a personal loan eliminates this concern. Usually, the approval process for a personal loan is quick and you can get approved within a couple of days.
Risks of Personal Loans
Since most personal loans are unsecured with no collateral attached, the lender takes on more risk when issuing the loan. As a result, unsecured personal loans require good credit for approval. Car shoppers with compromised credit are less likely to get approved for a personal loan compared to a traditional car loan where the vehicle serves as collateral for the lender.
In addition to requiring good credit for approval, personal loans typically come with higher interest rates than car loans. According to Value Penguin, the average interest rates on personal loans in 2019 ranged from 10% to 28% depending on credit rating. In comparison, the typical range for traditional auto loan APR rates is between 3% and 10%.
It's also important to consider the loan terms when choosing between a personal loan and auto loan. The terms for paying back a personal loan are generally shorter than for a traditional auto loan. While car loan terms range between 36 to 72 months, some personal loans need to be repaid in as little as 12 or 24 months. Shorter loan terms will amount to higher monthly payments.
Should You Get a Personal Loan to Buy a Car?
Going the traditional car loan route will be the best choice for the majority of car shoppers, but there are some exceptions. The first factor to consider is your credit rating. If you have good credit, getting a personal loan can give you more flexibility with the timing of the purchase and the type of vehicle. It will also protect your vehicle from repossession in the event you default on the loan. On the other hand, if your credit history is rocky, a personal loan will be difficult or even impossible to obtain. In this case, it's best to shop around for a subprime car loan and get pre-approved by several lenders to find the best interest rate.
The type of vehicle you plan to buy will also determine the best loan type. Shoppers looking at older used cars, classic cars, or those who want to buy from a private seller can benefit from a personal loan since there are no requirements for how to use the funds. Car shoppers who want to buy a new or preowned vehicle from a dealership will find the convenience and lower interest rates of a traditional car loan to be a better fit.