Should I Take Out a Personal Loan for a Car?

Acquiring a vehicle often involves navigating various financing options. Understanding the fundamental characteristics of different loan types is important for making an informed choice when funding a car purchase. Each financing method carries distinct implications for monthly payments, overall cost, and borrower responsibilities.

Personal Loans for Vehicle Acquisition

A personal loan provides a borrower with a lump sum of funds from a lending institution for purposes including buying a car. These loans are unsecured, meaning they do not require the car as collateral. The borrower receives the funds directly and uses them to purchase the vehicle. This means the personal loan lender cannot repossess the vehicle if the borrower defaults, though other financial consequences, such as damage to credit scores, would still occur.

Interest rates for personal loans are higher than those for secured loans, reflecting the increased risk to the lender due to the absence of collateral. Rates can vary widely, from single digits up to 35% or more; the average for a 24-month personal loan has been around 12.17%. Loan terms for personal loans range from six months to 84 months, or approximately seven years. A borrower’s credit score significantly influences both the approval of a personal loan and the interest rate offered, with higher scores leading to more favorable terms.

Traditional Car Loans

A traditional car loan is a secured loan where the vehicle being purchased directly serves as collateral. The lender provides funds directly to the car seller, and the vehicle’s title is held by the lender until the loan is fully repaid. If a borrower fails to make payments, the lender can repossess the car to recover the outstanding debt. The presence of collateral reduces the lender’s risk, which translates to lower interest rates for the borrower compared to unsecured personal loans.

Average interest rates for traditional car loans vary based on whether the vehicle is new or used, and the borrower’s creditworthiness. In the first quarter of 2025, the average interest rate for new car loans was about 6.73%, while used car loans averaged 11.87%. For borrowers with excellent credit, new car rates could be as low as 5.18%, but for those with lower credit scores, rates for used cars might exceed 21%. Common loan terms for traditional car loans range from 24 to 84 months, with the average length hovering around 67 to 72 months for both new and used vehicles.

Loan Selection for Vehicle Purchase

Choosing between a personal loan and a traditional car loan for a vehicle purchase requires evaluating several financial factors. Interest rates represent a primary difference, with secured traditional car loans offering lower rates than unsecured personal loans because the vehicle provides security for the lender. For instance, average new car loan rates are often in the single digits, while personal loan rates can range significantly higher, sometimes reaching over 30% depending on credit. Even small differences in the Annual Percentage Rate (APR) can lead to substantial variations in the total interest paid over the life of the loan.

The presence or absence of collateral is another distinction. A traditional car loan uses the vehicle as collateral, which can result in lower interest rates but carries the risk of repossession if payments are not met. Conversely, an unsecured personal loan does not use the car as collateral, removing the risk of vehicle repossession, though it may come with higher interest rates. Borrowers should consider their comfort level with this risk versus the potential for lower interest costs.

Loan terms also influence the total cost of borrowing and monthly payments. Both loan types offer terms ranging from a few years up to seven years or more. Longer terms can result in lower monthly payments but lead to higher total interest paid over time. Calculating the total cost of borrowing for each option provides a clearer picture of the financial commitment.

A personal loan might be considered in specific situations, such as when purchasing an older vehicle that may not qualify for traditional auto financing. It can also be suitable when buying from a private seller who does not offer financing, or if a borrower prefers to avoid using the car as collateral. Additionally, if a borrower’s credit profile unexpectedly yields a personal loan rate that is more favorable than available car loan rates, this option could be explored.

Traditional car loans are preferred for new or late-model used cars purchased from dealerships due to their lower interest rates. These loans are the standard choice for buyers seeking the lowest possible financing cost and who are comfortable with the vehicle serving as collateral. The structured nature of traditional car loans streamlines the purchase process with dealerships.