by Christy Bieber | Aug. 11, 2019
Car loans and personal loans are both term loans, but there are important differences. Find out about car loans vs. personal loans here.
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.
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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Let’s look more closely at why these differences matter when deciding whether to get a car loan or a personal loan.
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.
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.
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.
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.
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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