Personal Loan vs. Auto Loan: How to Choose

Key takeaways

• With a personal loan, you won’t need a down payment to buy a vehicle.
• Auto-loan lenders might place limits on what they’ll lend for a used car.
• Unless you are paying in cash, check your credit report before you start shopping.

When financing a new or used car, there’s an important decision you’ll need to make: personal loan vs. auto loan. There are benefits to both. In this article we’ll explore some of the differences between personal loans and auto loans.

When you buy a car, whether a new car or used, it’s often a big investment. For most people, a car purchase comes in second only to buying a home. Perhaps you’ve just started shopping, or maybe you’ve already picked out the new car you want. Either way, you’ll need to decide how to pay for it and which financing options are right for you.

To see the estimated impact of different financial moves—before you make them—try Best Egg Financial Health’s Credit Simulator tool. Choose from options like a credit limit increase, foreclosure, and more, and our tool will let you know what it could do to your credit score. 

Should I use a personal loan to buy a car?

In some cases, using a personal loan to buy a vehicle could be a better option than an auto loan. Personal loans work differently—they are typically unsecured loans, meaning there’s no collateral at stake. The lending institution can’t repossess your car if you miss payments. However, they can take other collection actions. Here are some other things to consider about auto financing with a personal loan:

• The loan term is sometimes more flexible when you use a personal loan. Most car loans are offered with fixed 36- to 60-month terms. Most personal loans start at 12-month repayment periods. If you’re planning on an early payoff, using a personal loan to buy your car might save you some interest.
• You don’t need a down payment if you use a personal loan for the purchase price of the vehicle. And with the funds already on hand, you could make a deal, on the spot, to get the car you want.
• Some auto loans have higher minimum amount requirements. If you want to buy an older, used car for $6,000, you might struggle to find a lender with good terms. But most any personal loan will cover those lower amounts.
• When budgeting, it’s helpful to know what your future monthly payments will be. With a personal loan approval, you’ll know how much the payments are, and for how long you’ll make them. That might be easier to factor into your budget than when you’re sitting in a dealer’s office, listening to a sales pitch.
• When comparing lenders for personal loans, you can shop from home. You can check out online lenders and see what unsecured personal loans fit your particular needs. Plus, you have time to review terms, limits, and credit requirements.

What’s an auto loan?

Auto loans are usually geared toward buying a specific car. They are a form of secured loan, where the lender holds the vehicle’s title as collateral. Auto loans tend to have lower interest rates than many personal loans. That’s because auto lenders can repossess your car if you fall behind on your payments, reducing their risk. In a sense, the lender owns your vehicle until your final payment is made.

Auto loans are often restricted in other ways as well:

• Most lenders have limits on mileage and vehicle age. If you’re looking for a used car, these limits could be a deal breaker. Many classic cars or restoration projects might have a tough time qualifying for auto loans.
• A down payment is often required. For the lender, this reduces their risk even more. But it takes money from your pocket up front. A lack of a down payment might result in a loan with a higher interest rate or even prevent loan approval.
• Some consumers apply for an auto loan after finding the car they want to buy. The approval time could cause you to lose the car to another buyer. Or if you’re denied the loan, the time you spent is wasted.
• With an auto loan, you’re stuck with the lender your dealer works with. You probably won’t be able to shop around for a better interest rate or loan terms. You apply—and what you get is what you get.
• Some auto loans have prepayment penalties. Be aware of this if you plan to pay off the loan early. And there also may be origination fees or dealer fees attached to the loan approval process. 
• Many auto loans will require you to maintain full insurance coverage on your vehicle, including liability, collision, and comprehensive. That might be expensive, and if the car is an older one, you may not want or need full coverage.

But there’s a positive note. With most auto loans being secured loans, lenders might view poor credit in a more favorable light. You might expect higher interest rates and higher loan payments if your credit score has dipped. But you may be approved at a dealership trying to make a sale, rather than through independent lenders looking for borrowers with excellent credit.

What’s the next step for personal and auto loans?

Before you go further, it’s best to check your credit report. Go to annualcreditreport.com and register for an account. Consumers can get their own credit reports for free, at least once a year. Review your credit history and make sure there aren’t any errors that might reduce your credit score. If you find anything wrong, contact the responsible credit bureau. File a dispute—they have to investigate and report back to you with their results. 

If you have other credit issues—like outstanding payments or defaults—take the time now to address them. Call your lender and make payment arrangements. You want your credit to be as strong as possible. Good credit usually gets you a lower interest rate and helps with loan approvals. 

Free credit scores are sometimes available from your bank, your credit card company, your credit union, or loan statements. It’s handy to know your score, and whether you should work on improving it or if it’s good to go.

Some financial institutions let you “pre-qualify” for personal loans. This should not affect your credit score. It lets you know the loan’s annual percentage rate, how much you qualify to borrow, and the monthly payment amount. That’s handy for when you go shopping for a new or used vehicle.

Do all your credit shopping within a 30-day period. The 30-day application window keeps multiple quotes from lowering your credit score. And no matter what type of auto loan or personal loan you use, always read the fine print. And keep an eye out for extra fees or penalties. 

This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.