Buying a car? Know your loan options

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Ask a Lender
April 7, 2017 | Updated September 26, 2017


Key Points

Comparing auto loans and personal loans

  • Auto loans are secured, so rates can be lower than personal loans.
  • In both, credit scores influence loans amounts and rates.
  • Unlike auto loans, personal loans help you own the vehicle outright.

It’s no secret that auto dealers are looking to make money. One of the ways they do that is by offering car buyers attractive financing deals through finance companies affiliated with the auto manufacturers whose cars they are selling.

Buyers may get an excellent deal this way as some captive auto-finance companies offer no-interest loans on specific vehicles. If you can’t find these bargains — which are most prevalent during summer when that year’s models are being phased out — or you don’t have great credit, or your mind is set on a purchasing a vehicle that doesn’t qualify for zero interest, there are other financing options out there.

Personal loans

Personal loans differ from auto and mortgage loans because they are generally unsecured, meaning they don’t involve collateral.

With auto and mortgage loans, a lender can seize your vehicle or home if you don’t make payments. There’s nothing to seize in the case of most personal loans, although a lender can sue you in court to recover what’s owed if you’re in default — and that can result in a judge ordering that your wages be garnished.

Personal loans differ from credit cards, which normally have variable interest rates. Personal loans are a form of installment loan, meaning fixed repayment schedules and, usually, fixed interest rates. You’ll receive a lump sum up front, then pay back the principal plus interest on a monthly basis. The terms generally range from two to seven years.

Obtaining a personal loan often depends on your credit score. Simply put, loan amounts are larger and interest rates are lower as your credit score rises.

There are risks associated with any installment loan, including those used to fund a vehicle purchase, however. First, the borrower must pay off the balance by the end of the term, which can sometimes involve a large balloon payment. Second, some personal loans include prepayment penalties that kick in if you pay the balance prior to a certain date.

Auto loans

Unlike personal loans, auto loans through a third-party lender are secured, meaning the lender can repossess the collateral — the vehicle — if the borrower defaults. Having that security allows lenders to offer friendlier interest rates.

While interest rates are fixed, the amount you wind up paying depends on how long the loan lasts. The characteristics of auto loans have changed in recent years, with terms of 72 or 84 months becoming commonplace. Although longer terms keep monthly payments lower, it also means you’ll pay more interest over the life of the loan.

Again, auto dealers, working with an inhouse automaker-owned finance company or independent lenders, often entice borrowers with offers of low- or no-interest loans, which works for the person with good or excellent credit. But if your credit score falls into the subprime category, or you have little to no credit history, it’s likely you’ll be charged a much high interest rate and forced into a larger down payment or require a co-signer with good credit.

Pros and cons

There are benefits to auto loans and personal loans, and the type that works best depends on your situation. Auto loans through a dealer or independent lender, such as a credit union, typically offer attractive rates and terms for creditworthy borrowers willing to provide a lender with a lien on the vehicle until the loan is paid off. Lenders also will require that a borrower maintain collision insurance coverage on the vehicle as a way of protecting their collateral.

Borrowers with good credit, however, should generally take advantage of low-interest financing offers. Essentially, the lender is offering you a way to spread out payments while charging little to nothing up front. It’s the best of both worlds.

If you’re looking for an older-model vehicle, obtaining financing through a dealer may not be an option. Typically, vehicles older than seven years aren’t worth enough for lenders to loan against. Also, if you’re interested in owning the vehicle outright, an unsecured personal loan can deliver on a faster timeline, because a lender will not retain a lien against the vehicle.

Also, by paying with cash via personal loan, you may have more bargaining power at a dealership. There’s less incentive for dealers to haggle with a cash buyer — by teasing low rates to offset a higher sales price, for example — because you won’t be financing the deal through one of their affiliates. It’s best not to tell the dealer you plan to pay with cash until you settle on a price, however.

Credit unions are often the best place to secure a personal loan. Since they’re nonprofit entities, they’ll usually charge lower interest rates. Personal loans offer more flexibility than secured auto loans — also available through credit unions and other independent lenders — because you can borrow an amount below or above the actual value of the vehicle. Personal loans are available in wide-ranging amounts, from $1,000 to $50,000 in many cases.

If you’re taking out a personal loan from an online lender, investigating them through the Federal Trade Commission or Better Business Bureau is highly recommended to avoid those with unscrupulous practices.

Your budget should also be a consideration. If you have a relatively small amount of cash available to you through a personal loan, you could invest in a used vehicle that may have higher miles and more deficiencies. Or you could turn the cash from a personal loan into a down payment on a newer vehicle that will likely be more dependable and then seek an auto loan to finance the balance of the vehicle’s cost. This might cost you more in interest payments long term, but that cost might be offset by the lower maintenance expenses for a newer vehicle, especially if the vehicle still has all or part of its warranty still in effect.


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