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3 reasons to use a personal loan to buy a used car

Bankrate logo Bankrate 3/4/2022 Mia Taylor
Used cars banner | Pamela Moore/E+/Getty Images © Provided by Bankrate Used cars banner | Pamela Moore/E+/Getty Images

If you're shopping for a used car, it can sometimes make sense to use a personal loan for the purchase rather than an auto loan.

First, you may not be able to find conventional financing for the vehicle. A personal loan may also make sense when your credit isn't good enough to qualify for a conventional used car loan. The final situation is when the interest rate on the loan is lower than what you would get using conventional, secured, financing.

Auto loans vs. personal loans

While an auto loan may be the most common way to finance a car purchase, it's also possible to use a personal loan. These two types of financing have some big differences to be aware of when deciding which one makes the most sense for your needs.

Auto loans and personal loans are similar in that they are both installment loans, meaning you will make monthly payments over a set period of time. Your income and credit history will be key to getting approved with either type.

Auto loan

An auto loan is a secured loan specifically designed for the purchase of a vehicle.The vehicle itself will serve as collateral should you default or fail to repay the debt. This means the car can be repossessed if the loan becomes delinquent.

Personal loan

A personal loan, on the other hand, can be used to cover the cost of many different types of financial needs from medical expenses to the costs of a wedding or debt consolidation and yes, a car purchase.

However, unlike when using an auto loan, the vehicle does not serve as collateral for a personal loan. The loan is riskier for the lender, so the interest you'll pay on a personal loan tends to be higher. In addition, the repayment timeline may be shorter compared to an auto loan.

When to use a personal loan to buy a used car

In some cases, you may find that it makes more sense to use a personal loan to buy a car, or a personal loan may be the only option available to you depending on the type of car you're interested in purchasing.

1. Conventional financing is not available for the vehicle

If you're considering purchasing a car of a certain age, it may not always be possible to secure conventional auto financing. Some lenders or banks may draw the line at financing a vehicle that is more than 10 years old. You may also find that lenders require older vehicles to have less than 100,000 miles to finance the purchase.


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2. Your credit is not good enough for an auto loan

If you have less than ideal credit, getting a car loan may be difficult. In some cases, you may only qualify for a subprime auto loan, which can be extremely costly.

Borrowers who have a subprime credit score pay the highest interest rates. The average interest rate on a subprime used car loan during the third quarter of 2021 was 15.91 percent, according to Experian data. The interest rate on a prime used car loan, by comparison, was 5.35 percent.

Subprime lenders should only be considered if you have no other options available. Shopping for a personal loan may provide a far better alternative.

3. Your personal loan rate is lower than an auto loan rate

Though interest rates on unsecured personal loans tend to be higher, if you have outstanding credit, you may qualify for a competitive interest offer, one that makes a personal loan a better choice than an auto loan.

Benefits of using a personal loan for a used car

Opting for a personal loan over an auto loan when buying a used car can have some benefits.

One of the most notable upsides when financing a purchase this way is that the loan is unsecured, meaning it's not backed by any collateral such as the vehicle itself. Should you fall behind on payments, the car will not be at risk of repossession.

Unlike when you're buying a car with an auto loan and you must find the vehicle first, the funds from a personal loan are available to you in advance of selecting a car. This can be useful if you're thinking about making a purchase from a private seller.

You also avoid having to make a down payment on the car purchase when using a personal loan.

Disadvantages of using a personal loan

There are also some downsides to consider before pursuing a personal loan for a used car purchase.

For instance, because personal loans are unsecured and therefore riskier for lenders, the approval requirements will be stricter and you will likely pay a higher interest rate than you would with an auto loan.

In addition, the risk factor associated with personal loans often means you will have a shorter repayment timeline than with an auto loan.

Finally, when using a personal loan you may not be able to access as much cash as you would when using an auto loan that's specifically designed to cover the cost of a vehicle purchase.

Bottom line

When buying a used car, a personal loan can sometimes be the way to go, rather than a traditional auto loan.

Before making a decision between a personal loan and an auto loan, however, consider using an online loan calculator to crunch the numbers and determine which option makes the most sense financially. Because personal loans are unsecured and don't require providing collateral, they often come with a higher interest rate and shorter repayment timeline than an auto loan.

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