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How should you finance your car? – Forbes Advisor

Personal Loan Vs Auto Loan: How Should You Finance Your Car?

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New cars don’t come cheap, and unless you have plenty of cash, you’ll probably need to finance your vehicle. People who bought cars at the end of 2020 borrowed an average of $35,228 for a new car and $22,467 for a used car, according to a recent report from Experian, one of the top three credit agencies. credit assessment.

With so much money at stake, you might be wondering which type of loan is best for you: a car loan or a personal loan? Although you can use either type of loan to finance a car, one may be a better choice than the other for your situation. We’ll explain everything you need to know to make the right decision.

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Main differences: personal loan vs car loan

What is a personal loan?

A personal loan is a type of unsecured loan that has a wide range of uses. Many people take out personal loans to consolidate debt at a lower interest rate, pay for home repairs or improvements, or cover car repairs. You can use personal loans for almost any type of expense, including financing a new car.

Personal loans usually come with higher interest rates than car loans because personal loans are unsecured compared to secured loans.

Although you usually don’t need to put down a deposit, your lender may charge an origination fee. If this is the case, you can often ask the lender to take it out of the loan proceeds, so you will need to calculate how much extra you need to borrow to cover these costs. For example, if you borrow $12,000 with an origination fee of $500, you will get $11,500.

Qualification Requirements for Personal Loans

Lenders look at several factors when applying for a personal loan, and each sets their own specific qualification requirements. In general, you will usually need a good credit score (670 or higher) to qualify. Lenders will also look at your income to make sure you can afford the loan repayments. If you are self-employed, you may need to provide two years of tax returns to prove that you have a consistent income history.

Related: The best personal loans of 2022

What is a car loan?

A car loan, on the other hand, is a secured loan that uses your car as collateral. This means that if you are late on payment or default, the lender can repossess your car to recoup their losses.

Since the lender is guaranteed to be paid one way or another, it is less risky for them to lend you money. And because it’s less risky, they pass those savings on to you in the form of a lower interest rate, which can save you a lot of money over the life of your loan.

Car Loan Eligibility Requirements

Just like with personal loans, each auto lender has their own qualification requirements. Since auto loans are secured, they can often be easier to obtain, especially if your credit isn’t the highest. Although we recommend a score of at least 670 for the most favorable terms, you may qualify for an auto loan with a lower score, depending on your debt-to-income ratio (DTI) and the amount of the loan. ‘deposit.

Additionally, getting a car loan can be trickier in some ways, as most lenders are only willing to lend on certain model years or vehicle types. For example, if you are financing an old car or a repairman, it may be difficult to find a car loan. However, if you are looking for a new car for your daily commute, chances are a lender will lend you the money for a car that you choose and can afford.

Advantages and Disadvantages of Using a Personal Loan Over a Car Loan

Advantages of financing a car with a personal loan

  • No deposit: The main reason to choose a personal loan to pay for a car is that you don’t need a down payment.
  • Less risk of recovery: If you default on the loan, your lender won’t repossess your car (not right away at least, they can still sue you).
  • Less restrictive: You can use a personal loan to buy any car you want as long as you can afford it.

Disadvantages of buying a car with a personal loan

  • Much more expensive: Personal loans come with higher interest rates than car loans. According to the latest average rates of the Federal Reservetwo-year personal loans are almost twice as expensive as four-year car loans (annual percentage rate (APR) of 9.65% vs. 4.95%).

Benefits of buying a car with an auto loan

  • More affordable: Auto loans are simply cheaper. If you took out a five-year, $25,000 loan using the interest rate above, you’d pay $56 less per month on a car loan and save $3,340 in interest when you pay off the car. .
  • Easier to get: You don’t usually need to have such a good credit score to get a car loan, although that certainly helps.

Disadvantages of buying a car with an auto loan

  • May not be able to borrow for all cars: Lenders have thresholds for determining the age of a car in order to finance it. It should also generally be in working order. A car loan may not work if you want to restore an old classic car.
  • Need a deposit: Most lenders will require some sort of down payment. If you haven’t saved a down payment, it can be difficult to get approved for a car loan.
  • The lender can repossess your car: You can lose your car very quickly if you are late on payment or fail to repay the loan.
  • Usually requires car insurance: When you take out a car loan, you’ll likely need to take out all-risk insurance, which can be expensive.

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