Personal loan vs auto loan: what’s the difference?

Personal loans vs auto loans: an overview

If you are looking for a large purchase like a car, you may need to take out a loan to cover the cost. Two of the most common financing options are personal loans and auto loans. Assuming you meet their respective loan requirements, they can be relatively easy to obtain.

So what’s the difference between the two? A personal loan can be used for many different purposes, including buying a car, while a car loan (as the name suggests) is strictly for purchasing a vehicle. Each type of loan has its own advantages and disadvantages; it is important to weigh them and compare them before signing on the dotted line.

Key points to remember

  • A personal loan can be used for many different purposes, while a car loan is strictly for the purchase of a vehicle.
  • A personal loan can be secured against something of value, or more commonly, unsecured.
  • A car loan is secured by the vehicle you intend to purchase, which means that the vehicle serves as collateral for the loan.
  • Either way, good credit usually means it’s easier to get approved and offered better loan terms.

Personal loan

A personal loan provides the borrower with funds from a lending institution (usually a bank), in the form of a lump sum that the borrower can use at their discretion, for example for a vacation, wedding or a home renovation.

A personal loan can be secured against something of value, like a vehicle or a house, allowing the lender to foreclose on your asset to recoup its losses if you don’t pay back the loan. However, most of the people go for an unsecured loan which means that the loan is made without collateral.

Two key things that affect the total amount paid on a loan are the interest rate and the length of the loan. A personal loan calculator can be a useful tool in determining how these factors will affect what you will pay each month.

Interest rate

Generally, unsecured loans have higher interest rates than comparable secured loans with collateral attached. Unsecured personal loans also come with much stricter approval requirements, so you will need great credit on your side. If yours is in bad shape, a personal loan might not be an option.

Your credit score will influence both the loan amount and the interest rate, which can be fixed or variable. The better your credit rating, the higher your borrowing capacity and the lower your interest rate. Conversely, the worse your credit rating, the lower your borrowing capacity and the higher the rate.

The inconvenients
  • Interest rates should be high

  • Stricter loan requirements

  • Consumers with poor credit scores will not be eligible

Terms

Personal loans have a fixed repayment period, expressed in months: 12, 24, 36, etc. Longer loan terms will reduce your monthly repayment, but you will pay more interest over the life of the loan. Conversely, shorter loan terms mean higher monthly repayments, but result in less interest overall because you pay off the principal faster.

Most lenders accept personal loan applications online, and you can often get approval for a car loan on the spot at the car dealership.

Car loan

A car loan is secured by the vehicle you intend to purchase, which means that the vehicle serves as collateral for the loan. If you default on your repayments, the lender can foreclose on the auto. The loan is repaid in fixed installments throughout the life of the loan. Much like a mortgage, the lender retains ownership of the asset until you make the final payment.

In order to determine the interest rate and loan term that would best suit your needs before you head to the dealership, consider experimenting with a car loan calculator first.

Interest rate

Since the lender has financial control over the car (it is a secured loan), the debt is considered to be of lower risk, which usually results in a significantly reduced interest rate for the borrower. The interest rates are also fixed, so borrowers are not subject to the increases that can be associated with unsecured personal loans.

Advantages
  • Usually a lower interest rate

  • Easier to get with a poor credit history

  • Often a practical “on-site” financing solution

Terms

Most auto loans are set at 36, 48, 60 or 72 months. And just like the personal loan, the shorter the duration, the higher the monthly payment and vice versa. A below-average credit history won’t necessarily come between you and your car loan (unlike a personal loan). It will also have less of an impact on your interest rate or the amount of your loan, which is dictated by the price of the car.

There are different ways to get auto credit. Before taking out a dealership loan, it can be helpful to research whether a local bank or credit union can offer you a better deal.

Special considerations

Whether you choose a personal loan or a car loan, the rates and offers vary by institution. So do your homework and look for the best deal. Explore banks, credit unions, and other lending platforms to find the best combination of interest rate and loan term for an affordable monthly payment.

The bottom line

When it comes to buying a new car, many consumers will opt for a dealer funded auto loan because it is quick and convenient. But in some cases, it may be more effective to get a personal loan instead. To make an informed decision, start by asking yourself these questions:

  • Do I have collateral with which to secure the loan?
  • What interest rate (and associated repayments) can I really afford?
  • Is my credit in good enough condition?

Deciding between the two comes down to weighing the pros and cons in light of your personal situation.


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