If you’re in the market for a major purchase like a car, you may well need to take out a loan to cover the cost. Personal loans and car loans are two of the most common financing options. Assuming you meet their respective lending 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, whereas a car loan (as the name implies) is strictly to purchase a vehicle. Each loan type bears its own pros and cons; it’s important to weigh and compare them before signing on the dotted line.
A personal loan provides the borrower with funds from a lending institution (generally a bank), in a lump sum that the borrower can use at their discretion, such as for a vacation, wedding, or home improvement.
A personal loan can be secured against something of value, such as a vehicle or home, allowing the lender to seize your asset to recover its losses if you don’t repay the loan. However, most people opt for an unsecured loan, which means the loan is made without collateral.
Two key elements that affect the total amount paid on a loan are the interest rate and the loan term. A personal loan calculator can be a useful tool for determining how these factors will affect what you’ll pay for each month.
Generally, unsecured loans have higher interest rates than comparable secured loans with collateral attached. Unsecured personal loans also come with much more stringent approval requirements, so you’ll want excellent credit on your side. If yours is in poor shape, a personal loan might not be an option.1
Your credit score will influence both the loan amount and the interest rate, which can be fixed or variable. The better your credit score, the higher your borrowing capacity, and the lower your interest rate. Conversely, the poorer your credit rating, the lower your borrowing capacity and the higher the rate.
A car loan is secured against the vehicle you intend to purchase, which means the vehicle serves as collateral for the loan. If you default on your repayments, the lender can seize the auto. The loan is paid off in fixed installments throughout the loan. Much like a mortgage, the lender retains ownership over the asset until you make the final payment.
In order to determine what interest rate and loan term would best suit your needs before you head to the dealership, consider experimenting with an auto loan calculator first.
Given that the lender has financial control over the car—it’s a secured loan—the debt is deemed a lower risk, which generally translates to a significantly reduced interest rate for the borrower. Interest rates are also fixed, so borrowers are not subjected to the increases that can be associated with unsecured personal loans.