Pros and Cons of Personal Loans vs. Auto Loans
Buying a car is one of the biggest purchases most people make, second only to buying a home. Deciding how you’re going to finance a car is important, and potentially expensive. You need to decide whether you want to go with a personal loan versus a car loan. Do you get a commercial bank or a credit union to finance your car or do you go with dealer financing? It’s more complicated than you think. The decision of personal loan versus a car loan can cost you hundreds, and maybe thousands, of dollars.
Qualifications to Buy Your Car
If there are any errors in your credit history, fix those before applying for a loan. If you are leaning toward a personal loan, your credit score will have to be higher, usually around 600, than if you want to get a car loan at a dealership.
Also, you will want to get together a down payment if you are going to try to get a personal loan instead of a car loan. If you are going to try to get a car loan, you can use a trade-in if you have one.
You can’t use a trade-in at a bank.
Check with your bank to see what their requirement is for a down payment on a car loan. If you have a low credit score, you will need a larger down payment.
Your Income Is Still Important
Your income is just as important as your credit score and credit history. Both a banking institution and a car dealership will use the debt/income ratio in order to evaluate how much total debt you have relative to the income you make both before and after your car loan.
Be sure the car you want is within your budget. Your lender will also evaluate the loan/value ratio, which is the amount you ask to borrow relative to the value of the car, to see if you can afford the car.
Pros and Cons of Using Personal Loans
Since personal loans are handled differently from an auto loan, they have a unique set of benefits and disadvantages for you as the buyer.
- Signature Loan – One of the biggest advantages of getting a personal loan vs a car loan is that there is no collateral involved. You agree to the terms of the loan with the bank and the bank accepts your signature. The loan is an unsecured loan. Your car is not used as collateral, so if you can’t make the payments the car is not taken away from you.
- Bank Relationship – You already have a relationship with your bank or credit union. That relationship may help you negotiate a better interest rate on the loan. It also may serve you well if you must be late on a payment or miss a payment entirely. Your car would not be repossessed.
- Cash in Hand – If you have cash in hand from a personal loan from a bank or credit union, you can take that to a car dealer. If you offer the dealer cash, you can probably get a lower price for the car you want. If you are buying from a private seller, the same is true.
- Interest Rates – Even though you may have a relationship with the bank, the interest rates, and annual percentage rate may be higher when using a personal loan vs, a car loan since the bank does not require collateral and the loan is unsecured. The higher interest rate compensates the bank for the increased risk.
- Approval of Loans – The approval rate of car loans is lower for personal loans to buy a car through a commercial bank or credit union since your credit score must be higher.
- Incentives – Incentives that dealers can offer, like rebates and 0% financing, are not available through banks or credit unions.
- Comparison Shopping – Car dealers have a network of banks from which they find financing for customers. If you get a personal loan from one bank, you won’t have access to that kind of comparison shopping.
No collateral involved.
You already have a relationship with your bank or credit union. That relationship may help you negotiate a better interest rate on the loan.
If you have cash in hand from a personal loan from a bank or credit union, you can take that to a car dealer.
The interest rates and annual percentage rate may be higher when using a personal loan.
The approval rate is lower.
Banks don't offer incentives.
You lose comparison shopping.
Buying a Car Through a Dealer
Often, the first place many people think of when it comes time to purchase a car is to go through the dealer's financing process. This type of financing does have some benefits.
Many dealers offer incentives to buyers. The dealer may be able to offer low-interest rate financing due to comparison shopping, or even 0% financing, that a bank or credit union can’t compete with. Also, it is convenient as you are already there doing your shopping. The dealer can offer you on-the-spot financing when you buy your car. If you have so-so credit, it may be easier to be approved. Approval rates on dealer-financed loans are slightly higher than on personal loans.
However, when you buy a car using dealer financing, you are taking out a secured loan and the collateral is the car you are buying. If you miss a payment, you are in danger of having your car repossessed.
The dealer may have to markup the price of the car in order to make any money. The increase in the price of the car may not compensate for the lower interest rate you might get from the dealer. It may make more sense to negotiate a deeply discounted price with the dealer and pay for the car with a bank loan if you can qualify.
You get comparison shopping.
Higher approval rates.
Your car is collateral.
Buying a car is one of the biggest purchases you will probably make in this lifetime. Be sure you understand your options on financing and go with the source that will give you the best bang for your hard-earned buck.
Factor to Consider When Buying a Car
- Your budget
- Your income
- Price of the car
- Interest rate offered
- Term of the loan (in years) offered by the lender
- Can you afford to pay the car off faster and have a lower term and lower interest rate, but higher monthly payments?
- Have you decided? Personal loan or car loan?