Understanding the Difference Between a Personal Loan vs. Car Loan

Most people find that they need to make one or more major purchases in their lifetime. Whether it’s a home or a car or another big-ticket item, many people must take out a loan to complete the purchase. In this article, we’ll look at the differences between a personal loan and a car loan when purchasing a vehicle. 

Understanding the differences and similarities between personal loans and car loans can help make the best decision for your financial situation. There are many factors to consider such as interest rates, loan time frame, secured versus unsecured, and so forth.

In this article, we’ll look at:

• What is a Personal Loan?
• What is a Car Loan?
• Personal Loan Rates and Terms
• Car Loan Rates and Terms
• How to Get a Personal Loan or a Car Loan

What is a Personal Loan?

A Personal loan is a loan you can take out to fund a large purchase or to cover a major expense, which might include a wedding, a sudden or unexpected medical issue, a home remodel, or even a car.

With a personal loan, a bank or lending institution lends a lump sum to the borrower at an agreed-upon interest rate and repayment time frame. Personal loans can be offered as either secured or unsecured loans, and it’s important to understand the difference between the two.  

A secured loan must require the borrower to put up collateral. Collateral is simply a valuable item or asset you use as security against your loan, such as a house. Here, if you default on your loan, the lender can seize the asset to recover its losses.

With an unsecured loan, you don’t have to offer any collateral against your loan. Unsecured loans are helpful if you don’t have any assets like a house or a car to use as collateral. However, there may be added drawbacks like higher interest rates and shorter repayment periods.  

Another factor to understand is the origination fee. The origination fee is a processing fee that a bank or lending institution will charge when you take out a personal loan. The fee can be between 1% to 8% of the total loan and either paid in cash or taken off the loan.

What is a Car Loan?

As the name indicates, these loans fund car purchases. Car loans are secured loans as the car you purchase is the collateral against your loan. Just like a mortgage, the bank owns the vehicle until you have made the final payment. In the event you default on a car loan, the lender can reclaim the car to cover their losses. 

Car loans typically require a down payment or deposit, but certain dealerships may offer special incentives. You can apply for a car loan at the dealership and compare different dealerships to find a favorable interest rate and monthly installment amount.

Personal Loan Rates and Terms

With Personal loans, your interest rate may vary depending on whether you take out a secured or an unsecured loan. For unsecured loans, your interest rate may be higher, and getting approved has stricter obligations.

Here is where your credit score comes into play. Your credit score is your credit history detailing how responsible you are at making payments and servicing debts. The score ranges from 300 – 850, and most lenders like to see a credit score around 650.

Your score level will not only determine if you get approved but the amount of interest you pay. That’s why it’s critical you consistently repay all your debts on time.

The terms can vary depending on your credit history and what you can handle. Most personal loans have a repayment time frame of between one to seven years. Moreover, the interest changes depending on how long you repay the loan. Taking longer to repay the loan incurs higher rates.

The average personal loan interest rate is between 10% to 28%. To break this down in more tangible terms, let’s look at a simple comparison between the two types of loans for buying a $25,000 car:

Car Loan Rates and Terms

The interest rates for car loans tend to be lower than personal loans as they are secured. Since the newly purchased car serves as collateral, lenders are able to offer fixed interest rates. In this case, borrows don’t have to worry about rate increases compared to the offers you may get with unsecured loans.

Car loans have their own set of requirements, and you need to submit a credit score and proof of income. You may be able to get a car loan with a slightly lower credit score, as the car will be collateral.

For the payment terms, car loans require you to pay a deposit upfront. Most car loans have a fixed repayment time frame from 36 months right up to 72 months; the shorter your time frame, the lower your interest rate. 

Comparing Personal Loan & Car Loans

Personal loans and car loans serve similar functions but also have some differences, which you can compare in the chart below.