Personal Loan vs. Auto Loan: Which Should You Choose to Buy a Car?

Buying a new or used car is an exciting prospect, and nothing beats that new car smell. However, it can also be stressful or overwhelming, especially if you need help paying for the vehicle. Few people have enough money saved to buy a car in cash. In fact, Experian found that 85% of new passenger vehicles are financed.

If you’re researching your financing options, you may be thinking about taking out a personal loan rather than an auto loan. The idea can be appealing: You can get the money you need in as little as a day, and there’s no need to use collateral or make a down payment. But is it a wise decision?

Here’s what you need to know about personal loans vs. auto loans.

Personal loan vs auto loan: How are they different?

When it comes to financing options, you can use either a personal loan or auto loan to buy a car. However, they work very differently from one another.

Personal loans

Personal loans are offered by banks, credit unions, and online lenders. They’re typically unsecured, meaning they don’t require you to put down any property as collateral. Instead, lenders look at your creditworthiness — meaning factors like your credit score, income, and current debt — to decide whether or not to issue you a loan and to determine your interest rate. And personal loans don’t require a down payment.

Personal loans offer more flexibility than auto loans. Lenders usually don’t have restrictions on how you use the money, so you can take out a loan to pay for a car, finance a vacation, or to consolidate high-interest credit card debt.

Personal loan interest rates can vary widely; you’ll see rates as low as 5% and as high as 30%. Because personal loans are unsecured, they tend to have higher interest rates than secured loans. According to the Federal Reserve, the average interest rate on a personal loan with a two-year loan term was 10.16% as of the third quarter of 2022.

Auto loans

Like personal loans, auto loans are offered by banks, credit unions, and online lenders. However, auto loans are secured, meaning your car serves as collateral on the loan. And lenders often require you to make a down payment for some of the car’s value.

Because they’re secured, car loans tend to have lower interest rates than personal loans. According to Experian, the average interest rate on a car loan for a new vehicle is 5.16%.

When is a personal loan better than a car loan?

In most cases, it makes more sense to take out an auto loan than to apply for a personal loan to buy a car. However, there are some exceptions to the rule:

• You’re buying an older vehicle: Many auto loan lenders have age restrictions on vehicles. For example, Bank of America prohibits lending for vehicles over 10 years old. If you’re buying an older model, such as a classic car, you may not be eligible for a car loan.
• You want to buy a high-mileage car: If you’re buying an inexpensive car with high mileage, it might be hard to get a loan. Many lenders have limits on car mileage. For example, CarFinance requires vehicles to have less than 100,000 miles for a borrower to be eligible for a loan. In this case, you may have to use a personal loan.
• You’re buying from an individual rather than a dealer: If you’re buying a car from a private party, you’ll likely need to pay cash, and they’ll want the money right away. With a personal loan, you can get the funds disbursed to your bank account in as little as one business day. Then you can withdraw cash from an ATM.

When is an auto loan better than a personal loan?

Using an auto loan to buy a car is a sound financial decision in the following scenarios:

You’re buying a newer vehicle

If you’re buying a new vehicle or a used car that’s less than 10 years old with under 100,000 miles, it’s likely a better idea to take out an auto loan than a personal loan. You should have no trouble qualifying for a loan with that car’s age or mileage, and you’ll be able to get a lower interest rate than you probably would with a personal loan.

You’re purchasing a car from a dealership

If you’re buying a car from a dealership rather than a private party, an auto loan is usually a better approach. You can secure your own financing ahead of time through a bank or a credit union. Or you can work with the dealership to find a loan. You may be able to save even more money with this strategy, as dealerships often offer 0% financing to qualified candidates.

You need to borrow more money

Because personal loans are usually unsecured, lenders will review your income and credit score to decide how large of a loan to offer you. If your credit score is less than stellar, you may be able to qualify for only a small loan that’s insufficient to buy a car.

By contrast, auto loans are secured, so you can usually qualify for a higher loan amount than you’d get with a personal loan.

You need a longer repayment term

In general, personal loans tend to have shorter repayment terms — usually between two and five years. By contrast, auto loans often have longer possible terms. You could qualify for a loan term as long as seven years, reducing your monthly payment.

Keep in mind that a longer loan term isn’t always a good thing. Over the course of your loan, you’ll pay more in interest fees than you would with a shorter term. However, that trade-off may be worth it to you to get more breathing room in your monthly budget.

How to find the best financing option for your car

Follow these steps to find the best financing options for you:

1. Review your credit report: Before shopping for a car, make sure you review your credit report; you can do so for free at AnnualCreditReport.com. Look for any errors or fraudulent activity, and take steps to resolve any issues you find. Ensure all of your accounts are up to date so you have the best possible credit when you shop for a loan.
2. Research several auto loan offers: Look up offers from different auto loan lenders, including a mix of options from credit unions and online lenders. Shopping around will help you find the best deals for your situation. Check out our guide on how to get a loan for more details.
3. Compare with personal loan offers: Before moving forward, compare the potential auto loans you found with personal loan offers. You may find that a personal loan is more cost-effective for your needs, especially if you’re buying an older or high-mileage car.
4. Consider getting a cosigner: If you can’t get a loan on your own — or if the interest rate is higher than you’d like — consider applying for a loan with a cosigner. A cosigner is a friend or relative who signs the application with you. They’re responsible for payments if you fall behind, decreasing the lender’s risk. With a cosigner, you’re more likely to qualify for a loan and score a low interest rate.
5. Talk to the dealership: If you have excellent credit, it might make sense to talk with the dealership. Some offer promotional 0% APR (annual percentage rate) offers, so you can take months or even years to pay off your new car without incurring interest.

The final word on buying a car

While you can technically buy a car with a personal loan rather than an auto loan, it’s only a good idea in a small number of scenarios. In most situations, an auto loan will be more cost-effective, offering lower interest rates and longer repayment terms. By doing your research and comparing offers on both personal and auto loans, you can find a financing option for a new car that works for you.