Can you use a personal loan to pay off your car?

Many people turn to auto loans when buying a car. More than 85% of new-car purchases and nearly 37% of used-car purchases were financed with a loan in the second quarter of 2020, according to the Experian State of the Automotive Finance Market report. Over time, though, buyers might decide that their auto loan terms aren’t ideal, leaving them to consider ways to pay off their car ahead of schedule.

You can take out a personal loan to pay off your car, but it’s not always a good idea. Learn more about the factors to consider before using a personal loan to pay off your vehicle.

• Can you use a personal loan to pay off your car?
• Pros and cons of using a personal loan to pay off your car
• How to get a personal loan to pay off your car
• Should you get a personal loan to pay off your car?
• Other ways to pay off your car loan early

Can you use a personal loan to pay off your car?

You can use the funds from a personal loan for nearly any purpose.

While you aren’t generally allowed to use a personal loan to fund illegal activities or to do things like gamble, they’re otherwise pretty open-ended consumer products. This means that you can use a personal loan to pay off your car, in most cases.

If you’re considering using a personal loan to pay off an auto loan, it’s important to consider all the factors involved. Here are some questions to ask:

• What’s the interest rate on your new personal loan? Auto loans are secured by your vehicle, so they typically have lower interest rates than unsecured products, such as personal loans.
• Are there any fees? Some lenders charge fees for originating (or opening) your new loan. If you’re not saving more in interest than you’re spending in fees, your personal loan could cost you more than your car loan.
• When will you get out of debt? Even if a personal loan has a lower interest rate than your auto loan, you may wind up paying more in interest over the course of that loan if you choose a longer repayment term. Be sure to consider how much your new loan would cost you overall.

Pros and cons of using a personal loan to pay off your car

Using a personal loan to pay off your car has both advantages and disadvantages.

Pros of using a personal loan to pay off your car

• You may be able to get a lower interest rate. If you’re locked into an auto loan with a high interest rate, a personal loan may allow you to reduce your APR while you finish paying off your car.
• You may be able to lower your monthly loan payments. By snagging a lower rate, adjusting your loan term, or both, you may be able to reduce your monthly car payments with a personal loan.
• You may be able to remove a cosigner. If you purchased your car with a cosigner, and you now want to remove that person from your loan, taking out a new loan can shift financial responsibility to you entirely.

Cons of using a personal loan to pay off your car

• Origination fees can make personal loans more costly. Not all personal loan lenders charge origination fees. But if yours does, this added expense can mean that your new debt costs you more in the end.
• Interest rates are often higher. Auto loans are secured by the vehicle you purchase, but personal loans are typically unsecured. Since you don’t have to put up collateral, interest rates for personal loans are often higher than auto loans.
• You may pay more in the long run. When you take out a new personal loan, you can choose your repayment terms. If you choose a longer term than what’s left on your current auto loan, you may end up paying more in total interest over the life of the loan than you would paying your auto loan as scheduled — even if you get a lower interest rate.

How to get a personal loan to pay off your car

If you choose to get a personal loan to pay off a vehicle, take these steps to ensure that your new loan is the most financially sound option for your situation.

1. Check your credit. Checking your credit report before applying for a new loan helps you know where your credit score stands, and what sort of loan terms you might be offered. It can also help you identify any errors or fraudulent accounts that could affect your loan approval.
2. Compare personal loan lenders. Shopping around for lenders helps you find the best rates and loan terms, and can help you decide which lender offers the loan you need.
3. Apply for the loan. Once you’ve found a lender, it’s time to apply for the loan. You’ll typically need to provide identifying info and documents, such as your address, phone number, or a copy of your ID, and you may also be asked to upload pay stubs or other proof of income. The lender will consider your income, existing debt burden, monthly expenses, and credit history when deciding whether to approve you for a loan.
4. Pay off your auto loan. If you’re approved, you’ll pay off your auto loan balance with your personal loan funds. Ask your auto lender for a payoff quote to get the most up-to-date balance information, and be sure to get written confirmation that the loan has been paid. Once the loan is satisfied, your lender will release the vehicle’s title to you.

Should you get a personal loan to pay off your car?

Now you know that you can use a personal loan to pay off your car … but should you?

This is an individual decision, but there are some scenarios when it might make sense to consider paying off an auto loan with a personal loan.

You’ll save on interest

If paying off your auto loan with a personal loan would reduce your total interest paid, it might be worth considering. This might mean lowering your loan’s APR, shifting your repayment term, or both.

It’s important to calculate not only your monthly interest, but your total interest over the life of the loan and any fees associated with your new loan. That way, you can determine whether your personal loan will actually save you money.

You’re underwater on your car loan

Owing more on your car than it’s worth (called negative equity or being "underwater" on the vehicle) is a dangerous situation. If your vehicle were to be stolen or totaled, insurance would only pay up to its market value — if you owe the bank more than that, you’ll be expected to pony up the difference right away.

By paying off your auto loan with a personal loan, you protect yourself from any out-of-pocket costs associated with your vehicle’s unexpected replacement. You’ll still owe more than the value of your car, but the loan won’t be called due if the vehicle is stolen or totaled.

You don’t qualify for an auto loan refinance

Most auto loan refinance lenders have maximum loan-to-value (LTV) ratios that they’ll accept. This means that they’ll only refinance your auto loan if you have a certain amount of equity built up in the vehicle.

If your LTV is too high, you may not be approved for refinancing. Instead, a personal loan can help you "refinance" into a lower-rate product, but without the LTV requirement.

Other ways to pay off your car loan early

If using a personal loan to pay off your car isn’t the right answer for you, here are a few other ways to pay off your car loan early.

• Round up your monthly payments. Paying a little extra money toward your auto loan each month will help you save money and get out of debt sooner. One easy way to do this is to round up your payments if you can.
• Make a payment every two weeks. Making biweekly payments is another manageable way to pay extra toward your loan without feeling as much of a pinch. At the end of the year, you’ll have made 13 full payments instead of 12.
• Make one large additional payment each year. Whether you get a Christmas bonus or just have some savings set aside, making an extra payment each year can get you out of debt a lot sooner. It’ll also reduce the total interest paid on your loan.