General

Do you need to take out a personal loan or car loan to pay off your car?

Do you need to take out a personal loan or car loan to pay off your car?

If you’re looking to buy a new car but don’t have enough cash on hand to buy it in advance, you’re probably thinking about taking out a loan to help finance your purchase. Depending on your situation, a car loan or a personal loan can each be an ideal financing option.

Both personal loans and car loans are considered installment loans, which means that you make fixed monthly payments over a period of time. That said, there are several key differences between the two types of loan products that are worth knowing.

Below is a breakdown of everything you need to know about using a personal loan vs. a car loan to buy a car, with a closer look at how interest rates, eligibility requirements, and loan terms vary between the two.

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Personal Loans vs Car Loans

The most obvious difference between personal loans and car loans is that personal loans can be used to: finance any type of purchase, whether it be wedding expenses, home repairs, or a new car. Personal loans can also be financed through lenders, credit unions and banks. If you want more flexibility when it comes to what you finance the money with, a personal loan is a good choice.

Car loans, on the other hand, can only be used to purchase a vehicle and are usually financed through a bank, credit union, or other lender. You may also be able to go through a car dealership, who typically work with other lenders to provide you with a loan, although this can be a more expensive option. Auto loans also require a down payment, or a percentage of the loan’s value, and a larger down payment on a loan means you’ll have a lower principal to pay off later.

Another major difference between the two is that personal loans are unsecured loans while car loans are considered secured loans. In other words, car loans are backed by collateral – in this case the car – while personal loans are backed by nothing. If you decide to take out a car loan, a lender may impound your car if you fail to make your payments. However, if you fail to make payments on a personal loan, your credit score will take a hit and the lender could take legal action — which could ultimately lead to your assets, including your car, being seized.

Since personal loans are usually unsecured, they require you to have a higher credit score to qualify for a loan. In general, you must have a good credit score or a score above 670 to be eligible. However, there are some lenders that provide personal loans to people with bad credit, although these types of loans carry higher interest rates.

If you have good credit, there are many personal loans available with lower interest rates and without late payment fees, early payout penalties, or startup fees. Select ranked LightStream Personal Loans, PenFed Personal Loans and Discover personal loans as some of the best personal loan lenders.

LightStream Personal Loans

  • Annual percentage (APR)

    3.99% to 19.99%* when you sign up for automatic payment

  • Purpose of the loan

    Debt Consolidation, Home Improvement, Auto Financing, Medical Expenses, Wedding and Other

  • loan amounts

  • requirements

  • Credit needed

  • Origination costs

  • Early Payout Penalty

  • Late fee

PenFed Personal Loans

  • Annual percentage (APR)

  • Purpose of the loan

    Debt Consolidation, Home Improvement, Medical Expenses, Auto Financing & More

  • loan amounts

  • requirements

  • Credit needed

  • Origination costs

  • Early Payout Penalty

  • Late fee

Discover personal loans

  • Annual percentage (APR)

  • Purpose of the loan

    Debt Consolidation, Home Improvement, Wedding or Vacation

  • loan amounts

  • requirements

    36, 48, 60, 72 and 84 months

  • Credit needed

  • Origination costs

  • Early Payout Penalty

  • Late fee

Another thing to consider: personal loans typically have a repayment term of one to seven years, while auto loans typically have a repayment term of two to seven years. If you take out a loan with a longer repayment term, it may have a lower interest rate, but you could end up paying more total interest than you would with a loan with a shorter repayment term and a higher interest rate. Use a loan calculator to determine how expensive your loan will be.

Both types of loans sometimes have an origination fee, which is shown as a percentage of the loan amount that you pay the lender for taking out the loan. Personal loans usually have slightly higher start-up costs, but there are many lenders that offer personal loans without them, such as the three lenders mentioned above, as well as Marcus by Goldman Sachs Personal Loans.

In general, it is advisable to use a car loan to finance the purchase of a car as these types of loans tend to have lower credit score requirements and offer lower interest rates. According to a recent report from the Federal Reservethe average rate for a 24 month personal loan in May 2022 was 8.73% while the average rate for a 60 month car loan was 4.85%, so there is definitely a difference.

Still, it is worth looking at the type of conditions for which you qualify for both types of loans. Then think of the one with the lowest costs and interest, but also the one with the best repayment term.

What it comes down to:

Choosing between a personal loan and a car loan to pay for a car really comes down to what your financial needs are. If you are looking for a loan with a lower interest rate and not the best credit score, a car loan is a good choice. However, if you are looking for a loan that you can use for purposes other than buying a car, a personal loan is a good option as you can use that money for an unlimited number of expenses.

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Editor’s Note: Opinions, analyses, reviews or recommendations in this article are those of the Select editors only, and have not been reviewed, approved or otherwise endorsed by any third party.