To be clear, these are very specific circumstances that affect very few people buying cars. Even then, it’s not clear that using a personal loan to skirt auto lenders’ insurance requirements or to fund the purchase of a project car is the smartest financial move. But if you’re going to do it, a personal loan may be the only way.
Why you might not want to use a personal loan to buy a car
Traditional auto loans exist because they’re a better fit than a personal loan for the vast majority of used or new car purchases. Here’s why you might want to stick with the tried-and-true auto loan when buying a car:
- Personal loans can carry a higher interest rate than the average loan through a car dealer or bank. A traditional car loan is ultimately backed by collateral (in this case, the vehicle), a fact that keeps the interest rate down. After all, the lender knows that if you miss payments they can repossess the car, sell it, and recoup their losses. Most personal loans are not backed by collateral — as a result, lenders typically charge higher interest rates on personal loans. People with good credit, with very few exceptions, pay as much or more for a personal loan as for a similar auto loan. A handful of banks have rolled out unsecured loans (no collateral ) designed for auto purchases — with similarly low rates despite being unsecured — but only people with very high incomes and excellent credit scores qualify.
- Less time to repay. While the typical personal loan is repaid in three years, some lenders stretch out loans to five years. In contrast, car loans can have repayment terms of seven years, sometimes even longer. While I wouldn’t recommend stretching out a loan as long as possible, some borrowers simply need more time to repay an auto loan. If a longer loan term is a priority, an auto loan is the best way to go.
- Larger limits. All else being equal, it’s generally easier to borrow more money when the loan is backed by collateral than when it isn’t. A borrower who easily qualifies for a $20,000 auto loan may only qualify for a $10,000 personal loan. In addition, lenders often have hard caps of $40,000 or less for personal loans, whereas true auto loans usually have much higher limits for those with the income and credit score to support it.
The calculator below can give you a better idea of whether or not a personal loan is right for you. Play around with different loan amounts and loan terms to see what fits your budget.
View more information: https://www.fool.com/the-ascent/personal-loans/buy-car/