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Can I Use a Personal Loan to Buy a Car?
When it comes to the majority of personal loans, there are no restrictions on how a client may spend money. Those are essentially all-purpose loans; you can use them for any purpose, including buying a car.
However, this does not mean everybody can buy a car with a personal loan. There are some scenarios where it might not be possible:
- Poor credit rating – Your personal loan application might be denied due to poor credit rating. Most banks try to avoid lending people money with a poor rating because this increases their risk exposure.
- Insufficient income – You might not have sufficient income for the bank to lend your enough money to buy a car. In fact, according to CNBC, the average price for a used car is above $33,000. You can find cheaper cars, but chances are that you will need to borrow a considerable amount of money to afford them.
- No credit history – If you have no credit history, the chances are that banks might be very reluctant to lend your tens of thousands of dollars, the amounts needed to purchase a car.
- Very high DIT ratio – You might have a good rating, payment history, and regular income. However, your debt-to-income ratio might be too high due to other liabilities, such as mortgage and credit card debt. This measures what portion of your monthly income goes to service liabilities. Most banks want to see the DIT ratio at 36% or lower.
So as we can see from the above discussion, generally speaking, you can buy a car using a personal loan. However, there are still some requirements to get such a loan. Therefore, it is fair to say that this option is not for everyone.
Using a Personal Loan to Buy a Car - Pros and Cons
Like any other financial decision, buying a car with a personal loan has advantages and drawbacks. Let's take a look on them:
Since you are not applying for an auto loan, you can also buy old ones. As Bankrate suggests, some lenders do not issue auto loans for cars older than ten years.
So this leaves you with more options to consider.
With a personal loan, your car will not be used as collateral in the loan. The fact is that with auto loans, the bank can sell your car if you do not meet your debt obligations.
However, this will not be the case if you buy a car with a personal loan.
If you take out a personal loan, you will have cash at hand when negotiating with private sellers. They do not have to wait for your application to be approved.
So, in this case, private sellers might be more inclined to offer discounts.
The first obvious disadvantage of buying a car with a personal loan is that the interest rates on those generally tend to be higher than on auto loans.
The reason is simple: with auto loans, the bank has collateral to sell in the case of default. With a personal loan, the bank is exposed to more risk, increasing interest rates.
Some banks offer their clients rewards if you take out an auto loan with them. This can include discounts for auto insurance policies, fuel vouchers, and cash rewards.
Unfortunately, you will have no access to those benefits if you buy your car with a personal loan.
The exact length of the loan term depends on the bank in question. However, generally speaking, banks offer more extensive loan terms with an auto loan than with a personal loan due to lower risk.
As a result, customers can benefit from lower monthly payments.
Personal Loan vs. Auto Loan: What are the Differences?
When considering whether to take out a personal or auto loan for a car purchase, it is essential to keep in mind that those two are distinctly different loan products.
Here are some of the key differences between them:
- Purpose – With an auto loan, the bank requires you to spend borrowed money on a car purchase. You are just not allowed to spend this money on other categories. On the other hand, you can use a personal loan for any purpose, whether buying a car, buying groceries, gas, or anything else.
- Collateral – In the case of an auto loan, your car acts as collateral. If you do not keep up with car payments, the bank has a right to sell your car to recover potential losses. With a personal loan, this is not the case.
- Approval Process – Your credit score and credit history play a key role in your loan application's approval. However, at the same time, in most cases, it is easier to get an auto loan than a personal loan. The reason behind this is that, with an auto loan, the bank is exposed to less risk and might be more lenient towards loan applicants.
- Down payment – With auto loans, some banks might require you to make a down payment. The minimum payment might range from 10% to 20% of the car’s value. On the other hand, if you buy a car with a personal loan, you do not need to come up with a down payment.
When Getting a Personal Loan to Buy a Car Might be a Good Idea
After discussing the pros and cons of buying a car with a personal loan, it is important to recognize that there are several cases where using this approach might be a good idea:
if you want to buy an old one, it might not be easy to get an auto loan. This is because some banks do not allow you to buy a car via an auto loan if it is older than ten years.
Some other financial institutions might require you to choose your car from official dealers. Therefore, in many cases, if you want to buy an old car, your only option might be to do so with a personal loan.
You might want to ensure that your car will not be taken away if you fail to keep up with payments. To achieve that, you can come up with enough savings or buy a car with a personal loan.
Having cash at hand can be a significant advantage when negotiating with private sellers.
They know that if they give you some discount, you can come up with money immediately, without waiting before the bank approves the auto loan.
When Getting a Personal Loan to Buy a Car Might Not Be A Good Idea
At this point, it’s helpful to mention that there are also some scenarios where buying a car with a personal loan might not be the best idea and can even harm your finances. Here are some of those:
To get approved for credit cards or other types of loans, keeping your debt-to-income ratio within 36% or lower is important. However, interest rates on personal loans are higher than on auto loans.
As of March 2023, according to the Bank of America website, the interest rates on auto loans range from 5.5% to 9%. At the same time, the interest rates on personal loans at Wells Fargo range from 5.99% – 21.74% . We can see here that the differential can be significant.
The fact of the matter is that some people have a hard time controlling their spending.
If you feel that you might use some of the personal loan money for other purposes, it might be better to get an auto loan to avoid unnecessary spending.
The actual interest rates banks charge on loans is highly dependent upon the Federal funds rate set by the Federal Reserve. The interest rates on personal loans are higher than on auto loans.
So in times of high-interest rates, this differential can become even more significant, leading to large interest expenses. Therefore, in those times, it might be better to stick with auto loans, to save some money on the interest.
To get a personal loan, you need to have a regular income source and at least an average credit score. The bank might require some additional documents as well.
You can submit a personal loan application in person by visiting a bank. Alternatively, you can fill out the application online or through mobile banking.
The fact is that most personal loans do not have any restrictions regarding the purpose for which you will use the funds.
The only obstacle here is to qualify for the requirements for the personal loan.
Whether or not a personal loan is the best way to buy a car depends on your circumstances.
As described above, in some cases, it might make more sense to take out an auto loan instead of a personal loan to drive a car purchase.
There is no standard credit score that all banks require to get a personal loan. Every financial institution has its policies on this issue.
However, generally speaking, with most banks, your FICO score needs to be 600 or higher for the bank to approve your personal loan application.
Some banks might consider issuing loans to people with lower credit scores. However, interest rates on those sub-price loans are usually higher.
There is a slight drop in your credit score when you apply for new credit. However, in most cases, you will recover this loss within six months.
Your payments will also impact your credit score. If you make payments on time, this can certainly help you to improve your credit score.