Can I Use a Personal Loan to Buy a Car?

by Jordan Wathen | May 27, 2019

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Young woman smiling as she inspects the exterior of a blue car.

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A personal loan can be used for almost anything, including car purchases. However, just because you can use a personal loan to buy a car doesn’t mean you should. There are only a few circumstances, most of them relatively rare, where a personal loan is a better solution than a traditional auto loan to finance a vehicle.

Here’s the skinny on personal loans, when they make sense for car purchases, and when they don’t.

How personal loans work

Many loans are designed for a specific type of purchase (mortgages are for homes, auto loans are for cars, and so on), but personal loans are for anything. You can use the proceeds from a personal loan however you’d like, whether it’s to refinance debt, go on a vacation, or buy a car.

Personal loans essentially allow you to borrow against your future income. When deciding whether to give you a personal loan, a bank will look at your income, your credit score, and any existing monthly obligations you might have. From there, the bank can figure out how much it can lend to you, and on what terms.

Because a personal loan isn’t contingent on how you plan to use the money, there aren’t any outside forces that can throw a wrench in your plans. You might apply for a $10,000 personal loan with the plan to buy a car at some point in the next month or two. With cash in hand, you can confidently pay cash for a car you find on a dealer lot or online on websites like Craigslist or eBay. You don’t have to wait to find a car to buy to apply for a personal loan.

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When you accept a personal loan, the funds are typically disbursed by a deposit directly into a savings or checking account. If you accept a $10,000 loan today, you could easily have the money in your bank account in as little as 24 or 48 hours.

When it can make sense to use a personal loan to buy a car

To be clear, a personal loan isn’t a car loan -- they aren’t specifically issued for a vehicle purchase. There are some cases where it may make sense to use a personal loan to buy a car, rather than a traditional auto loan.

Here are some scenarios where a personal loan can make sense:

  • You’re buying a car from a private party -- Banks offer loans to purchase cars from individuals, but you’ll need to find a patient seller who is willing to jump through some hoops. Understandably, sellers who list their cars on Craigslist, eBay, or Bring-A-Trailer would prefer to be paid in cash or a cashier’s check rather than go through a multi-day process of waiting for you to get approved to buy their specific car. It can make sense to use a personal loan to fund the purchase. Later, after taking possession of the car, you can get a traditional auto loan against the car to repay (refinance, in other words) the personal loan balance. If you choose to go this route, a personal loan company that offers loans without origination fees (fees just for taking out a loan) or prepayment fees (fees for paying back the loan early) would be ideal.
  • You don’t want to carry full coverage insurance -- To get a traditional auto loan, you’ll need to carry “full coverage” car insurance for the vehicle, which includes collision and comprehensive coverage to provide financial protection against damage, theft, and other risks. If you use a personal loan to buy a car, you won’t have to carry full coverage auto insurance, which can save you some money at the cost of taking on more risk if you get in an accident, incur weather damage, or your car is stolen. There are situations where self-insuring against these risks can be worth it, though. If you want to buy a $3,000 car for a high-risk, 16-year-old driver, a personal loan and liability insurance may be less expensive than an auto loan and comprehensive insurance.
  • You’re buying a project car -- Sorry, shade-tree mechanics, most banks aren’t interested in making auto loans for cars that aren’t in road-worthy condition. Older cars, damaged cars, as well as cars with salvage or rebuilt titles can be difficult to finance with a traditional auto loan. If a car looks more like a pile of parts than an operable car, a personal loan may be the only way to finance it.

To be clear, these are very specific circumstances that affect a minority of people who are buying a car. 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 really the smartest financial move in the first place. 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 for the vast majority of used or new car purchases than a personal loan. Here’s why you might want to stick with the tried-and-true auto loan when buying a car:

  • Personal loans can carry high interest rates -- Whereas a car loan is ultimately backed by collateral (a car), a personal loan doesn’t have any collateral backing it. As a result, lenders typically charge higher interest rates on personal loans than car loans. People who have good credit will, with very few exceptions, pay as much or more for a personal loan as a similar auto loan. A handful of banks have started rolling out unsecured loans designed for auto purchases, with similarly low rates despite the fact they are unsecured, but only people with very high incomes and excellent credit scores will qualify.
  • Less time to repay -- While the typical personal loan is repaid in three years, some lenders will stretch out loans to five years. In contrast, car loans can be made with 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 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 at $35,000 or less for personal loans, whereas true auto loans usually have much higher limits for those who have the income and credit score to support it.

To summarize, you can use a personal loan to buy a car, and in some cases, it can be the easiest and most practical solution, but auto loans remain the most popular way to finance a car for the simple reason that they often offer the best mix of interest rates, repayment terms, and availability for the vast majority of car purchases.

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