Personal Loan or Car Loan: Which Should You Get?
by Christy Bieber | Aug. 10, 2019
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Car loans and personal loans are both term loans, but there are important differences. Find out about car loans vs. personal loans here.
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There are lots of different ways to borrow money for big purchases. And for many of us, one of our biggest purchases is a vehicle. If you’re buying a car, you may need to decide whether you should do so using a personal loan or a car loan. While car loans and personal loans have some similarities, there are also important differences between them.
Understanding these differences is essential because different people have their own needs when it comes to borrowing for a vehicle. Personal loans, for example, may be best if you want flexibility in where you buy your vehicle or what car you buy. Personal loans are also a better choice if you’d prefer a loan that doesn’t use the vehicle as collateral. But if your primary goal is to get the lowest interest rate possible or if you don’t have great credit and need a lender willing to be flexible in qualifying requirements, a car loan may be a better choice.
We’ll delve into the different features of a car loan vs. a personal loan in more detail below so you can decide which borrowing method is the best approach if you’re buying a vehicle.
What’s the difference between a car loan and a personal loan?
To decide whether to get a personal loan or a car loan, you need to understand how these loan types differ. Key differences between a car loan and a personal loan center around interest rates, collateral requirements, and the loan approval process.
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- Car loans use the vehicle as collateral and are secured loans; many personal loans are unsecured.
- Car loans often charge lower interest rates than personal loans because they are secured loans.
- You may be able to qualify more easily for a car loan due to the car acting as collateral -- although you should watch out for bad-credit auto-loan dealers offering loans with bad terms.
- Car loan lenders may limit you to using the funds only for vehicles that meet specific requirements with regards to vehicle make or mileage, or may be available only for vehicles purchased from dealers, while you can use personal loan funds for any purpose you want.
Let’s look more closely at why these differences matter when deciding whether to get a car loan or a personal loan.
Car loans put your vehicle at risk because the loan is secured
Car loans are structured so lenders have a legal interest -- an ownership interest -- in the vehicle that is serving as collateral for the loan. This makes it very quick and easy for the lender to repossess the vehicle in the event you do not make loan payments. Generally, lenders can repossess vehicles without going to court to get a court order and, in some states, even without providing you any notice.
When you get a personal loan, on the other hand, there’s usually no collateral because the loan isn’t a secured one. If you don’t pay an unsecured personal loan, it’s harder for lenders to collect. A lender could go to court and get a judgement against you that says you must pay what is owed. And if you still don’t pay, a lender could go back to court and get a court order to help them collect. This could lead to your wages being garnished or a lien being put on your property. However, you won’t typically lose your vehicle.
Lower interest rates on car loans could save you money
According to Experian, the average car loan interest rate in the U.S. in the last quarter of 2018 was 5.17%. The average personal loan rate, on the other hand, was reported by Experian as 9.37%.
Car loans tend to have lower interest rates than personal loans because of the fact they’re secured. These lower rates can make a huge difference in what you end up paying for your vehicle over time. If you borrow $25,000 over four years at 5.17%, your monthly payment would be $578 and your total interest costs would be $2,728. But if you borrowed the same $25,000 over four years at 9.37%, your monthly payment would be $627 and your total interest costs would be $5,073.
It’s clear which of these loans would be a better deal for the borrower. While you can and should shop around and compare rates, you’re very unlikely to find a personal loan offering a better rate than a car loan.
It may be easier to qualify for a car loan
Personal loan lenders have to count on your word that you’ll repay the loan since it’s unsecured. As a result, it’s difficult or impossible to get a personal loan on favorable terms if your credit isn’t great. While you can potentially qualify for a loan with a very high interest rate if you have a low credit score, you’d pay a ton to borrow.
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Because car loans are secured, getting approved for a loan tends to be easier if you don’t have a perfect credit score. Of course, bad credit can mean unfavorable terms for car loans too. However, if you shop around, you can usually find better deals for bad-credit car loans than for bad-credit personal loans.
If your credit isn’t very good, make sure you understand the terms of any loan you take out. Predatory lenders target bad-credit borrowers, especially those desperate for a car, and it does you no good to get a loan you can’t afford because this will just lead to repossession of your vehicle and make your credit worse.
Car loans have more restrictions on where the money goes
When you take out a personal loan, you can typically use the money for anything you want -- lenders just give you the cash.
This isn’t the case with car loans. Some car loan lenders only make loans through dealers. Others allow you to apply independently of a dealer but the money still has to be used to buy a car. And many car loan lenders have restrictions on what types of vehicles they will loan you money to buy. You may not be able to buy from an individual seller, buy a car that is too old, or buy a car with too many miles.
If you want a really old collectible car you’re going to have to fix up, for example, your only option may be to get a personal loan from a lender that doesn’t care what you’re using the money for.
Should you buy a car with a car loan or a personal loan?
While you can use both a car loan or a personal loan to buy a car, car loans tend to make more sense for most people because you could get approved for them more easily and will likely pay a lower interest rate. However, you will have to pledge collateral -- the car -- when you get a car loan, which means your vehicle is at risk if you don’t pay. You may also face more restrictions on the age or type of vehicle you can buy.
Ultimately, you’ll need to weigh the pros and cons of each loan type to decide which is best for your specific situation.
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About the Author
Christy Bieber is a personal finance and legal writer with more than a decade of experience. Her work has been featured on major outlets including MSN Money, CNBC, and USA Today.
We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.
