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New cars don’t come cheap, and unless you have a stack of cash, you will likely need to finance your vehicle. People who bought cars at the end of 2020 borrowed an average of $ 35,228 for a new car and $ 22,467 for a used car, according to a recent report by Experian, one of the top three rating agencies. credit.
With so much money at stake, you may be wondering what type of loan is best for you: an auto loan or a personal loan? While you can use either type of loan to finance a car, one may be a better choice than the other for your situation. We’ll explain everything you need to know to make the right decision.
Key differences: personal loan and car loan
What is a personal loan?
A Personal loan is a type of unsecured loan which has a wide range of uses. Many people take out personal loans to consolidate debts at a lower interest rate, pay for home repairs or renovations, or cover auto repairs. You can use personal loans for almost all types of expenses, including financing a new car.
Personal loans generally have higher interest rates than auto loans because personal loans are unsecured vs secure.
Although you usually don’t need to make a down payment, your lender may charge a creation costs. If this is the case, you can often ask the lender to withdraw it from the loan proceeds, so you will need to calculate the additional amount to borrow to cover these costs. For example, if you borrow $ 12,000 with a setup fee of $ 500, you will get $ 11,500.
Personal loan eligibility conditions
Lenders look at several factors when you apply for a personal loan, and each defines its own qualification requirements. In general, you will usually need a good credit rating (670 or more) to qualify. Lenders will also look at your income to make sure you can afford the loan repayments. If you are self-employed, you may need to provide two years of tax returns to prove that you have a consistent income history.
Related: The best personal loans of 2021
What is an auto loan?
A automatic loan, on the other hand, is a secured loan who uses your car as collateral. This means that if you fall behind on payments or default on the loan, the lender can repossess your car to recoup its losses.
Since the lender is guaranteed to get paid somehow, it is less risky for them to lend you money. And because it’s less risky, they pass that savings on to you in the form of a lower interest rate, which can save you a lot of money over the life of your loan.
Qualifying Requirements For Auto Loan
Just like with personal loans, each auto lender has their own qualifying conditions. Since auto loans are secured, it can often be easier to qualify, especially if your credit is not the highest. Although we recommend a score of at least 670 for the most favorable terms, you may be able to qualify for a car loan with a lower score, depending on your debt / income (DTI) and amount of the deposit.
Plus, getting an auto loan can be trickier in some ways, as most lenders are only willing to lend on certain model years or certain types of vehicles. For example, if you are financing an old car or a repairman, it can be difficult to find an auto loan. However, if you are looking for a new everyday car, chances are a lender will lend you money for a car you choose and can afford.
Advantages and disadvantages of using a personal loan compared to the auto loan
Benefits of financing a car with a personal loan
- No deposit: The main reason for choosing a personal loan to pay for a car is that you don’t need a down payment.
- Less risk of rework: If you default on the loan, your lender will not repossess your car (at least not right away – they can still sue you).
- Less restrictive: You can use a personal loan to buy any car you want as long as you can afford it.
Cons of buying a car with a personal loan
- Much more expensive: Personal loans carry higher interest rates than auto loans. According to the latest average rates of Federal Reserve, two-year personal loans are almost twice as expensive as four-year auto loans (9.65% vs. 4.95% annual percentage (APR)).
Benefits of buying a car with an auto loan
- More affordable: Auto loans are simply less expensive. If you took out a loan of $ 25,000 over five years using the interest rate above, you would pay $ 56 less per month on a car loan and save $ 3,340 in interest when you pay off the car. .
- Easier to obtain: You usually don’t have to have such a good credit rating to get a car loan, although that certainly helps.
Disadvantages of buying a car with an auto loan
- May not be able to borrow for all cars: Lenders have thresholds for the age of a car in order to finance it. It should also be generally in working order. An auto loan may not work if you want to restore an old classic car.
- Need a deposit: Most lenders will require some sort of down payment. If you haven’t saved up a down payment, it can be difficult to get approved for an auto loan.
- The lender can repossess your car: You can lose your car very quickly if you are late or default on payment.