What's the Difference Between a Personal Loan and a Car Loan?

by Christy Bieber | Updated April 5, 2022 - First published on Aug. 24, 2021

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Two people sitting at a desk in a car showroom and handing signed forms back to the salesperson.

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A personal loan can be used to buy a car, but that doesn't make it a car loan.

Most people can't afford to pay cash for a vehicle, so they'll need to borrow money for it. And that raises the question of what's the right sort of financing for this purchase?

You may be wondering, "Can you use a personal loan to buy a car?" Or are you better off with a car loan? To make that choice, you need to understand the differences between how auto loans work and how personal loans work.

To help you decide, here are four key differences between a personal loan and car loan.

1. Personal loans can be used for any purpose, but car loans can only be used for one purpose

When personal loan lenders give you a loan, you can use the money for anything you like. Lenders often don't even ask what you're doing with the cash.

That means if you want to buy a car with the money, you can. Or you can pay for a wedding, home renovations, or a big purchase of just about anything else you want.

Car loans, on the other hand, can only be used for one purpose -- to buy a car.

2. Car loans are secured debt, while many personal loans are unsecured

A car loan is a type of secured debt. The car acts as collateral for the loan. That means the lender has a legal interest in the car. The lender usually holds the car's title until the secured loan is paid in full. If you don't make payments, the lender can repossess the vehicle quickly and easily.

Personal loans, on the other hand, can be a secured or unsecured loan, but many are unsecured. That means there's no collateral. The borrower promises to repay, but there are no assets tied to the loan. If the borrower defaults, the lender could pursue legal action and try to get the court to put a lien on their property or garnish their wages, but this is complicated and time consuming. So a lender can't just take the car if the borrower doesn't pay.

3. Car loans can come with lower interest rates than personal loans

The interest rate on a car loan is usually lower than the interest rate on a personal loan. While the specific rate you'll qualify for varies depending on your financial credentials, it's not uncommon to be able to borrow at a rate under 3% to purchase a vehicle. Personal loans, on the other hand, often have interest rates higher than that.

4. It may be easier to qualify for a car loan

Since a car loan is a secured loan, the risk to lenders is relatively low. After all, if you don't pay, they can just take your car and sell it to get their money. Because lenders don't face much chance of losing a lot of money on a car loan, it's usually pretty easy to qualify for one. In fact, even people with bad credit can typically borrow to buy a car.

Personal loans, on the other hand, are riskier because they are unsecured. So lenders may have stricter qualifications in terms of credit and income. While there are personal loans for bad credit, they are harder to find, and the interest rate may be higher.

It's important to consider these key differences when deciding which of these loans makes sense for your vehicle purchase. Many people will find a car loan is the right choice, but that may not be the case in every situation.

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