The advantages of unsecured personal loans for auto purchases are not apparent at first.
Traditional secured financing typically works best. Pledging collateral often results in better interest rates, longer terms, and easier approvals. This translates into low monthly payments.
On the other hand, personal loans can help new and used car shoppers who do not fit into the traditional mold. Learn about the unique pros and cons.
- Get down payment assistance to improve qualifications
- Shop for cash only bargains by dealer, make, and model
- Avoid the hard cross-selling dealer finance and insurance person
- Cut out the middleman by offering cash to private sellers
- Protect your work transportation from repossession in the event of default
Unsecured Personal Loan for New Car Purchase
First, we look at the advantages of unsecured personal loans for new car purchases. This alternative is not ideal for every shopper, as traditional secured financing options exist for a reason.
Request a personal loan to help fund a vehicle purchase. A network of online lenders will evaluate your qualifications and may present offers. Compare the pros and cons of using the funding for a down payment, or instead of a secured contract offered through a dealer.
Taking out an unsecured personal loan for a down payment on a car purchase has several advantages.
- A large down payment offsets the immediate depreciation. Drivers are more likely to stay current on payments when they face losing a deposit after repossession.
- Buyers with poor credit scores often need a larger down payment to offset the higher default risk. People with good or excellent ratings can get by with less money down.
- The debt-to-income ratio (DTI) measures the buyer’s ability to make monthly payments. A down payment improves the percentage of this key indicator.
Opening a personal loan for a down payment on a car has drawbacks as well.
- Newly opened borrowing accounts can hurt credit scores initially.
- Shorter repayment terms push up the debt-to-income levels.
Bad credit borrowers with no down payment often have no other choice. They need some form of assistance coming up with a deposit in order to overcome a weak rating.
Versus Auto Financing
Compare personal loans versus traditional auto financing options before pulling the trigger. Learn the definition of unsecured versus secured financing and the consequences of each. Then contrast what it means to negotiate with the dealer versus the bank.
Unsecured vs Secured
Collateral is the difference between unsecured versus secured auto loans. In this case, the collateral is your set of wheels. Often this is the vehicle people need for transportation to and from work – where they earn an income to support their lifestyle.
Unsecured auto loans do not involve collateral. This means that a lender approves the application based on a signature promise to repay the contract on time with interest. The buyer takes immediate possession of the title.
- Pros of unsecured car loans
- Cash only buyers have negotiating power and flexibility with dealers
- The driver does not lose his or her transportation in the event of default
- The owner decides how much insurance to buy
- Cons of unsecured auto loans
- The interest rate is often higher without collateral
- Approval rates are often lower when backed only by a signature
- The amount may not be enough to cover the full sticker price
- Car repairs are often far less expensive
Secured auto financing does involve collateral. This means that the lender approves the application based on the buyer’s signature to pay and the pledged value of a vehicle. The lender holds the title until the borrower repays the lender in full.
- Pros of secured car financing
- Interest rates are often lower holding other qualifications constant
- Approval rates are also higher when the lender can resell the asset after default
- Longer repayment terms lower debt-to-income ratios
- Lenders are more likely to approve amounts close to the sticker price
- Cons of secured auto financing
- The owner could lose work transportation after a repossession due to default
- Buyers have less flexibility when choosing dealers and brands
- The lender requires expensive insurance coverage to protect its investment
Dealer Finance vs Bank
Flexibility is another important difference between auto dealer finance versus a personal loan from a bank or online lender. It boils down to who has control during the buying process.
Dealer finance and insurance professionals specialize in two things.
- They find willing lenders to facilitate purchases. Dealers make money when they move iron. Therefore, they are motivated to find a lender willing to approve each potential customer.
- They sell add-on services such as insurance, extended warranties, and security packages. Most dealers break-even on sales of new inventory. Their profit comes from these extras.
Banks specialize in lending money and collecting payments from borrowers. They make profits by pricing the cost of money accurately to reflect the risk of default. They may also cross-sell related insurance products.
Unsecured Personal Loan for Used Car Purchase
Now we consider the advantages of unsecured personal loans when purchasing used cars. The case is much stronger for pre-owned vehicles. People with marginal borrowing credentials prefer the flexibility, affordability, and assurance that they will not lose their work transportation.
High-risk drivers often prefer cash deals with private sellers for the reasons spelled out in the next sections.
Getting a personal loan with monthly payments for a used car purchase has pros and cons for buyers with bad credit history. People with low credit scores often buy used, since pre-owned vehicles have lower sticker prices.
High-risk borrowers are most likely to default. Therefore, the chances for repossession of the collateral become an important consideration, as do the odds for approval.
Permanent uninterrupted access to transportation is the primary benefit of a bad credit unsecured personal loan for a used car. High-risk borrowers cannot lose their work transportation needed to earn an income and support their family.
In the event of default, the lender cannot repossess the vehicle. They must file a lawsuit in court in order to attach a lie. The lien takes effect only when the owner sells or trades in the asset.
Approval rates are the primary drawback to a bad credit personal loan that does not pledge a used vehicle as collateral. Lenders face higher losses without the ability to repossess the asset in the event a default.
Therefore, lenders apply stricter approval criteria. This makes it more difficult for some shoppers to qualify. Aim for lower-priced alternatives to improve the approval odds.
Personal loan interest rates are less of an issue with used car purchases. The spread between the interest rates for secured versus unsecured financing is not as large.
Secured lenders find it more difficult to determine and verify the value of a pre-owned vehicle. They have limited insight into its maintenance, accident, or flood damage history. With the recent hurricanes in Texas and Florida, the potential for foul play is enormous.
Therefore, secured lenders charge higher interest rates when they cannot verify the value of the underlying pledged asset. This minimizes the biggest drawbacks of unsecured borrowing. The gap in the cost of money is smaller.
Personal loans simplify the used car buying process with private sellers. A cash-only transaction can overcome the obstacles private sellers often face. They do not have professional experience with financing, and cannot pre-certify the vehicle.
Private sellers rarely have a finance and insurance professional who specializes in matching borrowers to lenders. Often, it is just a person who wants to get a better price than the trade-in offer. They have no experience with financing and do not maintain a network of specialty lenders and insurance companies.
Private sellers often cannot pre-certify a used jalopy. They do not employ a department full of competent mechanics who can inspect the vehicle, and repair obvious problems. Secured lenders shy away from deals where the value of the collateral is harder to estimate and verify.