Personal loan vs. car loan: Which is better?

If you’re planning to buy a car, be prepared to make some big financial decisions before driving off the lot. Vehicle prices have soared in recent years, with Kelley Blue Book reporting that the average new car now costs around $50,000. Even used car prices remain elevated, making financing a key consideration for many buyers.

Traditionally, auto loans were structured around 5-year (60-month) terms, but recent trends show that buyers are opting for longer repayment periods. According to Experian™ data, the average car loan term is nearly 6 years, at 68.48 months for new cars and 67.41 months for used cars.

With cars becoming more expensive, it’s helpful to explore your financing options. While an auto loan might seem like the obvious choice, a personal loan could offer more flexibility depending on your situation. Let’s break down the differences to help you determine the best financing route for your next vehicle purchase.

Auto loan vs. personal loan: What’s the difference?

Before deciding whether to use a personal loan or an auto loan (also called a car loan) to finance your vehicle, it’s important to understand how both options work. Being familiar with how both types may impact your financial situation is crucial for making an informed decision.

What is an auto loan?

An auto loan is a secured loan that has your car serves as collateral. Since the loan is backed by the vehicle, it’s often easier to qualify for and comes with lower interest rates. However, rates and eligibility depend on the lender.

If you're considering an auto loan, having a down payment can help lower your overall loan costs. While some lenders offer zero-down financing, it usually means higher interest rates and more expensive payments.

Auto loans also come with restrictions. Many lenders only approve loans for certain cars, often newer models. That means while you might get financing for a brand-new vehicle, an older fixer-upper may not qualify.

What is a personal loan?

A personal loan is a type of credit that lets you borrow a set amount of money from a bank, online lender, or credit union. While some personal loans require collateral, most are unsecured and come with a fixed interest rate, a set amount of time to repay the loan, and no collateral.

Personal loans are popular because they’re flexible and can be used for many purposes. Some common uses include home improvement projects, debt consolidation, major purchases, and medical expenses.

Unlike an auto loan, a personal loan doesn’t require a down payment, but lenders may charge an origination fee. Once approved, you’ll make monthly payments until the loan is fully repaid. That’s why it’s essential to make sure you can commit to the established payment schedule before taking out a loan.

Can you use a personal loan to buy a car?

A personal loan can be used to buy a car, just like it can be used for many other expenses. It also provides more flexibility than an auto loan, especially if you’re purchasing an older vehicle for collecting or restoration. Unlike auto loans, most personal loan lenders don’t place many restrictions on how the funds are used.

One factor to consider is the loan amount. Personal loans typically range from $1,000 to $50,000, though some lenders offer up to $100,000. If you’re buying a car priced at $50,000 or less, a personal loan should cover the full amount. For example, with Rocket Loans^SM, you can borrow amounts ranging from $2,000 to $45,000.

Pros and cons of using a personal loan to buy a car

A personal loan can be an option for financing a car, so comparing it with an auto loan is wise. Here are a few key factors to consider before selecting one loan option or the other.

Pros of using a personal loan for a car

Personal loans offer flexibility and fewer restrictions compared to auto loans. However, it’s smart to consider the benefits against potential trade-offs before deciding if this is the right choice for your car purchase.

• No down payment required: Unlike auto loans, personal loans don’t require a down payment, which can be helpful if you need to finance the entire cost of the car. This can be a big advantage for buyers who don’t have cash on hand for upfront costs.
• More vehicle options: Once the loan funds are in your account, you’re free to buy any car, regardless of its age, model, or condition. Auto loans often have restrictions on the type of vehicle the lender considers acceptable, but personal loans don’t.
• No risk of car repossession: If you use an unsecured personal loan, your car isn’t tied to the loan as collateral. That means if you fail to make payments and default on the loan, the lender can’t take your car. However, you’ll still face financial consequences.

Cons of using a personal loan for a car

While personal loans offer flexibility, they also come with drawbacks compared to auto loans. Before choosing this option, consider the potential downsides that could impact your finances.

• Higher interest rates: Personal loans, especially unsecured ones, typically have higher interest rates than auto loans. This can make borrowing more expensive, meaning you could end up paying more in interest.
• No down payment can lead to financial risk: Auto loans often require a down payment, which helps offset a new car’s depreciation — around 20% in the first year. Without one, you might owe more than the car is worth right away, putting you “underwater.” This could also mean needing GAP (guaranteed asset protection) coverage, which adds to the cost of the loan but protects you if your car is totaled or stolen.
• Stricter loan qualifications: Personal loan lenders consider your credit score, income, employment history, and debt-to-income ratio when determining approval. This makes it harder for those with lower credit scores or high debt levels to qualify.
• Additional loan fees: Many personal loans come with origination fees ranging from 1% to 10% of the loan amount. If the fee is high, you might need to borrow more just to cover it, which can increase the total cost of the loan over time. Remember to factor these fees into your loan decision to understand the full financial impact.

Pros and cons of using an auto loan to buy a car

Since personal loans tend to have higher interest rates and stricter approval criteria, an auto loan may be the better option for financing your next vehicle. However, it’s still important to weigh the advantages and disadvantages before making a decision. Here are some considerations for using an auto loan.

Pros of using an auto loan to buy a car

• More affordable: Auto loans typically have lower interest rates and longer repayment terms, making them a more affordable option. Lower monthly payments and overall interest savings can help keep your monthly loan payments more manageable.
• Easier to qualify: Because an auto loan uses the vehicle as collateral, lenders are often more flexible with their credit requirements. Even if your credit score isn’t perfect, you may still qualify for an auto loan.
• Convenient dealership financing: In addition to banks and credit unions, many dealerships offer financing options. A helpful tip: If you bring prequalified offers from other lenders, you can try to negotiate better terms at the dealership.

Cons of using an auto loan to buy a car

• Down payment requirements: Many auto loans require a down payment, which means you’ll need money upfront. While this can be challenging, a larger down payment might help you secure a shorter loan term and potentially lower interest rates.
• Risk of repossession: With your new car as collateral, not making payments could lead to repossession. While this is a risk, using collateral typically results in lower interest rates and better loan terms. Make sure you can make your payments to avoid this risk.
• Vehicle restrictions: Some auto loans have limitations on the vehicle's age, condition, or mileage they will finance. Lenders often prefer to finance cars that are newer or in good condition, which means purchasing a classic, project, or older vehicle might not be possible with an auto loan.

Personal loan vs. auto loan: At a glance

What to know about auto financing at the dealership

When you get financing through a dealership, they may mark up the interest rate, increasing your monthly payments. This markup happens because dealerships sometimes have agreements with lenders to add extra charges on top of the “buy rate” (the rate the lender offers) to make a profit.

To avoid paying more than you need, consider getting preapproved for a loan before visiting the dealership. This way, you can compare the rate from your lender with what the dealership offers and negotiate better terms.

When to use a personal loan or auto loan

Ultimately, choosing the right loan option for your vehicle depends on your personal situation, financial goals, and preferences.

A personal loan may be a good choice if:

• You have good or excellent credit
• You can't afford a down payment
• You're buying an older vehicle

An auto loan might be a better choice if:

• Your credit score or debt-to-income ratio is moderate
• You're purchasing a new car from a dealership
• You need a larger loan amount for the vehicle

How to get a personal or auto loan

Whether you're applying for a personal or auto loan, there are helpful steps to take before closing on a loan. Here’s what to do:

1. Review your credit report: Your credit history will be a key factor in loan approval. To start, check your credit report for errors that could decrease your score. You can access a free credit report at AnnualCreditReport.com, which won’t include your score but can help spot mistakes.
2. View your credit score: Check with major agencies like Experian™, Equifax®, or TransUnion® to view your credit score. Understanding your score can help you gauge the interest rates you might qualify for.
3. Shop around for lenders: Once you’ve decided on the type of loan you want, it’s time to explore lenders. Various lenders may offer different interest rates, fees, and terms. Compare offers from banks, credit unions, online lenders, and dealerships to find the best deal.
4. Apply for prequalification or preapproval: Prequalification helps you understand the loan amount and terms you may be eligible for, without affecting your credit score. Prequalification is usually a soft inquiry. However, preapproval involves a hard credit inquiry, which can impact your score. Although prequalification gives you an estimate, preapproval can provide a more accurate offer from lenders.

The bottom line: Weigh your loan options carefully

If you're torn between using a personal loan or an auto loan to buy a car, keep your budget, financial goals, and future plans in mind to make the best decision.

Auto loans can be more affordable, especially for new or used cars, but they often require a down payment. On the flip side, personal loans might be a better choice if you don’t have a down payment or prefer not to use your car as collateral.