You may need a car, but you’re not required to finance with specialized auto financing. You may want to consider the personal loan vs auto loan. For many, traditional auto financing offers lower interest rates and is the best choice. But not for everyone. Personal loans offer significant advantages that make them the best choice for some borrowers:
- Use a personal loan for your down payment to get better auto financing terms
- Access to cash-only bargains from private sellers or small dealers
- Protect your work transportation from repossession in the event of default
Before buying a car, then, it makes sense to compare personal loans vs car loans. The benefits of a personal loan may surprise you.
Auto loan interest rates
Your credit score very much impacts how much you pay for auto loans. Experian says there are five basic credit categories, though other sources might define these categories differently.
- Super Prime – 781-850
- Prime – 661 – 780
- Non-prime – 601-660
- Subprime – 501 – 600
- Deep Subprime – 300 – 500
If we look at these same categories we can see, on average how much they each paid for new car financing, according to Experian.
- Super Prime – 4.19%
- Prime – 5.01%
- Non-prime – 7.91%
- Subprime – 12.17%
- Deep Subprime – 14.88%
Many people, of course, buy used vehicles. Here again your credit standing can go a long way toward determining your financial costs. Below are the fourth quarter used vehicle auto loan rates by credit category.
- Super Prime – 4.69%
- Prime – 6.38%
- Non-prime – 10.91%
- Subprime – 16.78%
- Deep Subprime – 19.62%
What do the Experian numbers tell us? First, borrowers with a low credit score may pay four to five times as much interest as a prime borrower for an auto loan. This is a huge credit penalty. Seen another way, the credit benefits of paying bills on time and in full are overwhelming.
Second, maybe buying is not the right choice. Leasing might be a cash saver. The typical monthly auto lease cost is $448. The cash cost to lease is about $138 a month cheaper than auto loan financing, according to Experian. But, when the lease ends, you still need transportation and that means either another lease or the purchase of a new or used vehicle. Monthly costs continue, you remain on the payment treadmill.
When you buy a car, you own the vehicle once the payments are completed. Hopefully you can keep it running for years without making monthly vehicle payments. With lower monthly costs it should be easier to qualify for other forms of financing, such as a mortgage.
Auto loans are different
In order to compare auto loans vs. personal loans, you should understand how car loans work.
Consumers are generally familiar with the idea of lending. You borrow money and in exchange pay back the money borrowed with interest.This seems fairly straight-forward until you get to auto loans. Many auto loans, especially for subprime borrowers,, are anything but simple.
Auto loan interest is often calculated using the “Rule of 78s,” a system which effectively moves most interest costs to the start of the loan. This effectively means that paying off the loan early can result in borrowers paying interest on money that they did not borrow for the full term.
How does the rule of 78s work? The state of Mississippi describes the financing this way.
“The Rule of 78s is also known as the sum of the digits. In fact, the 78 is a sum of the digits of the months in a year: 1 plus 2 plus 3 plus 4, etc., to 12, equals 78. Under the rule, each month in the contract is assigned a value which is exactly the reverse of its occurrence in the contract. Hence, the 1st month of a 12-month contract gets the value of 12, the second month 11, etc., until the 12th month gets a value of 1. As the months elapse, the interest is earned by the lender equal to the total value of the expired months.
“For example, prepaying after 2 months of a 12-month contract would result in the lender being able to keep 29.49% of the finance charges (1st month 12 plus 2nd month 11 = 23/78 or 29.49%). In another example, if the borrower prepays after 6 months, the lender would have earned 57/78s or 73.08% of the finance charges.”
Importantly, auto loans with simple interest are also available from auto dealers such as CarMax. Typically these loans can be paid off in advance without penalty. For details and specifics ask the dealer.
Buying a car with a personal loan
Personal loans typically involve simple interest and are available from banks, credit unions, family members or through loan matching services, such as AmOne.com. They can typically be prepaid in whole or in part without penalty, but be sure to ask the lender about details.
With an auto loan, the car is security for the debt, the lender can take back the car if you miss a payment. Think about what that means: How do you get to work or school?
Because a personal loan is unsecured, there’s nothing to repossess. Your credit can suffer from missed payments but you should still have transportation. For many borrowers that’s better than auto financing — whether the interest is simple or not.