Lori Meadows
As a college student, buying a car can be challenging, especially if you're also managing student loan debt. While student loans can be used to cover transportation costs, federal student loans expressly forbid using the funds to purchase a vehicle. Additionally, student loan interest rates are typically higher than car loan interest rates, and student loans have longer repayment terms, resulting in higher overall costs. Therefore, it is generally not advisable to use student loans to buy a car. Instead, consider alternative options such as saving up for a used car, exploring auto loan options with a co-signer, or finding ways to reduce transportation costs without owning a car.
| Characteristics | Values |
|---|---|
| Use student loans to buy a car? | Technically, student loans are meant to be used for educational expenses. However, there is no oversight once the money is in your bank account. The US Department of Education prohibits the inclusion of car costs in the college's cost of attendance. |
| Student loan interest rates | Higher than the average rate for a car loan. Undergraduate student loan rates were 5.05% in 2018 compared to a 4.21% interest rate for a car loan. |
| Loan term for cars | The average loan term for cars in 2018 was 68 months (5-6 years). |
| Student loan repayment term | The standard repayment plan is 10 years, but income-driven repayment plans can extend the loan term to 20-25 years. |
| Alternatives to student loans for buying a car | Work a part-time job during semesters and summers; save up and buy a cheap used car; get a co-signer with good credit to co-sign the loan; opt for student-specific auto loan programs or lenders with flexible acceptance criteria. |
| Budgeting for a car | Calculate monthly expenses, including student loan payments, rent, utilities, and other bills, to determine how much you can afford to spend on a car. |
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What You'll Learn
Student loans cannot be used to buy a car
Student loans are meant to be used for educational expenses, including tuition, books, fees, supplies, and living expenses such as room and board. While the cost of attendance includes transportation, this refers to the incremental costs of travelling to and from school, not the cost of purchasing a vehicle.
The U.S. Department of Education has explicitly prohibited the inclusion of the cost of a car in the college's cost of attendance. This means that, unfortunately, you cannot use student loans to buy a car, no matter what type of student loan you have.
Student loan interest rates are also higher than the average rate for a car loan. Undergraduate student loan rates were set at 5.05% in 2018, while the average five-year auto loan had an interest rate of 4.21%. As a result, you will be paying off your car for a much longer period, possibly even 10-20 years after you bought it.
If you need a car, it is recommended that you work a job during the summer and weekends during the semesters to save up for a cheap used car. You could also look into getting a car loan, although this can be challenging for students due to their limited credit history and income. However, some lenders offer student-specific auto loan programs or have flexible acceptance criteria, and you can also add a co-signer to help improve your approval odds.
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Student loan interest rates are higher than car loan rates
Student loan interest rates are typically higher than car loan rates, so it's important to consider which loan to prioritise when deciding how to pay off your debts. While federal student loans offer flexible payment plans and the potential for debt forgiveness, the increased interest rates mean that you will likely end up paying more overall.
In 2018, the average five-year auto loan had an interest rate of 4.21%, while undergraduate student loan rates were set at 5.05%, and graduate loan rates at 6.6%. Direct Plus loans had even higher interest rates of 7.6%. With the standard repayment plan for student loans being 10 years, many graduates opt for income-driven repayment plans that can extend the loan term to 20-25 years.
When deciding whether to prioritise paying off your student loan or car loan, it's important to consider the interest rate of each loan. In most cases, it makes sense to pay down the loan with the highest interest rate first. However, if the interest rates on both loans are low, you may be better off keeping payments to a minimum and putting any extra money into a savings account. This could improve your net worth more than paying off your debt.
Additionally, if you have a stable career and are confident in your ability to pay off your debt over time, you may want to consider investing some of your savings in stocks for potential long-term gains. Ultimately, the decision between paying off student loans and car loans depends on your individual financial situation and risk tolerance.
While it may be tempting to use student loan money to buy a car, especially if you need one to commute to school, it is important to remember that student loans are intended for educational expenses. Using student loans to buy a car could end up costing you more money in the long run due to the higher interest rates. Instead, consider working a job during the summer or weekends to save up for a cheap used car, or look into student-specific auto loan programs with flexible acceptance criteria.
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Car loans for students are possible with a co-signer
While it is possible for students to secure car loans, it is not a simple process. Lenders want to see a credit history that includes a low debt-to-income ratio (DTI) and a good credit score. Most college students with loans have little to no income and a limited credit history.
One way to get around this is to add a co-signer. Adding a trusted co-signer who has a lengthy credit history and a higher credit score can help your approval odds. Your co-signer can be a friend or family member with high credit, income, or longer employment history. Keep in mind that your co-signer is also legally responsible for your car loan. If you’re not able to make the payments, it could cause friction in your relationship.
Additionally, some lenders use a good GPA to help determine eligibility or offer perks like discounts and lower interest rates for good grades. Lenders may also consider income in the context of being a student, but showing at least a few months' income, even part-time income, can help your approval odds.
You can also check if your school partners with any financial institutions that offer car loans for students. For instance, the USC Credit Union is connected to the University of Southern California (USC) and allows enrolled USC students to become members and access financial products such as auto loans. Some banks and credit unions offer programs to help students finance vehicles, and these may come with flexible eligibility requirements, like low or no credit score requirements. Credit union auto loans, in particular, tend to come with some of the lowest interest rates available.
Before taking out a car loan, it is smart to apply for loan prequalification to ensure you know the amount you can afford and skip out on dealership markups. You can also use a car payment calculator to determine a realistic budget and how much you can afford to spend each month.
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Save up for a down payment to reduce loan amount
Saving up for a down payment on a car can be challenging as a student, but it can significantly reduce the amount you need to borrow and lower your monthly payments. Here are some tips to help you save for a down payment while managing your student loans:
Calculate Your Budget
Determine your monthly expenses, including student loan payments, rent, utilities, and other bills. Figure out a realistic budget for a car by using a car payment calculator and focusing on the vehicle's out-the-door price rather than just the sticker price. This will help you understand how much you can comfortably afford to put towards a car without stretching yourself too thin.
Refinance Your Student Loans
Consider refinancing your student loans to lower your interest rates or monthly payments, freeing up more money for your car fund. However, keep in mind that if you have federal student loans, they will become private loans if you refinance, and you'll lose access to federal benefits like income-driven repayment plans and loan forgiveness initiatives.
Compare Interest Rates
Compare the interest rates of your student loans and potential auto loans. In most cases, it makes sense to prioritize paying down the loan with the highest interest rate. If you have the financial flexibility, you may be able to make larger payments towards your student loans with higher interest rates while still paying the minimum due on other loans.
Explore Auto Loan Options
If you decide to take out an auto loan, shop around for the best interest rates and terms. Lenders typically consider credit history and income as determining factors for interest rates. As a student, you may have a shorter credit history, impacting your approval odds. You can improve your chances by adding a trusted co-signer with a strong credit history or demonstrating a reliable source of income.
Save for a Down Payment
While saving for a down payment may be challenging, it is worth considering as it can reduce your overall loan amount. If possible, aim to save at least 20% of the purchase price of the car to secure lower rates and monthly payments.
Remember, student debt does not directly impact your ability to buy a car, but lenders will consider your debt-to-income ratio when evaluating your loan application. By saving for a down payment and managing your student loans wisely, you can work towards buying a car while effectively handling your student debt.
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Refinance student loans to free up cash for a car
While it is not recommended to take out additional student loans to buy a car, refinancing your existing student loans can free up cash that can be put toward a car fund. Refinancing your student loans may potentially lower your interest rates or monthly payments, giving you more financial flexibility.
However, it is important to note that refinancing student loans has its drawbacks. For instance, if you have federal student loans, they will become private student loans if you refinance, and you may lose benefits associated with your federal loans, such as income-driven repayment plans, deferment, and loan forgiveness. Additionally, choosing a longer refinancing term may lower your monthly payment but increase the overall interest paid over time.
Before deciding to refinance, carefully assess your budget and financial situation. Consider your income, expenses, and other financial commitments. Use a car payment calculator to determine how much you can afford to spend each month on a car, and save up for a down payment if possible.
It is also essential to understand the current interest rates when considering a personal loan for a car. High-interest rates will result in a more expensive loan, and you will have to pay it off over a longer period. Compare interest rates from different lenders and aim for the lowest offer possible to minimize costs.
While student loan debt does not directly impact your ability to buy a car, it can play a role in the loan application process. Lenders will consider your debt-to-income ratio when evaluating your creditworthiness. A high debt-to-income ratio may indicate higher financial risk to lenders.
In conclusion, refinancing your student loans can be a strategy to free up cash for buying a car. However, it is important to carefully consider the benefits and drawbacks of refinancing and to assess your financial situation holistically before making any decisions.
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Frequently asked questions
Technically, you could use part of your student loans to purchase a car. However, it is not legal to do so. Student loans are meant to cover the cost of attendance, which includes transportation costs, but not the cost of purchasing a vehicle.
Student loan interest rates are typically higher than car loan interest rates. This means you'll spend more in interest costs repaying a student loan than you would a car loan. Student loans also have longer repayment terms, which means you could be paying off your car for a decade or more, long after you sell or trade it in.
Lenders use an applicant's credit score and history to determine their ability to pay off loans. As a student, you likely don't have an extensive credit history. You can add a trusted co-signer with a lengthy credit history and a high credit score to help your approval odds. You can also look for lenders with flexible acceptance criteria, such as those that consider good grades or income.
You can save up money by working a part-time job during the school year or over the summer. You can then use this money to buy a cheap used car. You can also use rideshare apps such as Uber and Lyft, or consider car-sharing services like Zipcar if you only need a car occasionally.
