How They Differ: Car Loans & Personal Loans

ByJonathan MillerJul.17, 2018

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When it comes to getting a loan, make sure you get the right one for you
When it comes to purchasing a car, there are generally 2 main kinds of loans that customers consider: personal loans and auto loans. Before making a decision that could impact your finances for a significant period, you should always ask yourself if opting for a broader alternative, such as a personal loan, is better than one designed specifically for auto purchases.

What is a Personal Loan?

Personal loans are used by customers to borrow a small to medium-sized sum of money and are paid off on a set schedule – monthly, bi-weekly, or weekly. They can be secured – by using an asset as collateral, or unsecured – with no collateral, though the latter option results in loans with higher interest rates and slightly less favorable terms. Although some companies offer variable rate personal loans, many provide fixed rate options. Personal loans are also a simple fund transfer. Once a customer is approved for a loan, funds are transferred to their account and can be used for any reason they choose.

What is a Car Loan?

Car loans, also known as auto loans, operate in a comparable way to personal loans, with one major difference: auto loans are designed specifically for the purchase of a new or pre-owned car, so funds cannot be used for any other purpose. Auto loans also operate almost exclusively with fixed rate financing, and there are a variety of different financing solutions available. Bearing this in mind, it is easier to compare car loans and discover which is better for your specific needs. 

Interest Rates

One of the biggest differences between personal and auto loans is the interest rates. Personal loans are generally unsecured, meaning they are extended with no collateral. Inevitably, this raises interest rates significantly, and can lead to problems if you’re looking for an affordable way to finance your vehicle. Many personal loans providers will offer initial rates that are over 5.00%, even to customers that have excellent credit.

On the other hand, auto loans are considered secured by default, as the car being purchased acts as the collateral. This means that car loans usually offer more favorable interest rates, with some lenders charging as little as 2.50% for customers that have excellent credit. Some of the top lenders that offer competitive rates like these include LendingTree, AutoGravity and LightStream. Overall, auto loans offer better rates due to their structure, and can help customers find better financing terms over the long-term when paired with flexible repayment periods.

Loan Terms

One of the biggest deciding factors when applying for a loan is the repayment term – how long a loan will take to be paid off. Personal loans are meant for customers who are looking to finance a short-term expense such as a major purchase, a medical emergency, or other urgent need. As such, loan terms will be on the lower side of the spectrum, ranging from as little as 1 year up to 5 years on the higher end. These terms are an excellent solution for smaller loan amounts, but can become problematic for larger sums.

Auto loans start with a longer repayment term as a base. Repayment options tend to start at 24 to 36 months, and can extend up to 84 months, although many experts recommend slightly shorter periods. While it may seem unreasonable to lock yourself into a longer loan term, higher sums of money become easier to pay off over an extended period, reducing the monthly amount to be paid and allowing for greater financial flexibility when it comes to planning budgets. Instead of being forced to pay off an exorbitant sum every month with a personal loan, with an auto loan you can take advantage of the extended repayment period and choose a car you really want without having to worry about stretching your finances.

Approval Requirements

Qualification requirements may sometimes change depending on whether a loan is secured or unsecured. Loans that are secured by collateral such as a car are considered less risky than other kinds of financing, and will generally offer both lower interest rates and better qualification requirements. When it comes to auto loans, many lenders are more willing to work with customers that have less than stellar credit and are therefore able to offer better interest rates, as they are absorbing less risk with the transaction. This makes finding an auto loan a less daunting affair even for those with weaker credit scores.

Personal loans are generally unsecured, meaning that requirements for approval are far more stringent. This also means that customers with better credit scores will be subject to higher interest rates and are less likely to find the terms they desire in certain cases. Additionally, customers with poor credit who apply for personal loans may be saddled with high interest rates and unfavorable terms, which could be a damaging factor for creditworthiness in the long-term.

Loan Amounts Available

Owing to their nature as a short-term solution, personal loan amounts are not designed to be high. Some companies offer a broad range of loans up to hundreds of thousands of dollars. However, most personal lenders prefer only to extend loans that are more likely to be repaid in short order. Personal loans tend to range from $1,000 to $50,000, although it is important to note that these amounts vary from company to company, and some may offer much higher or lower amounts. These amounts are like those offered by auto loans, and are useful for many situations. Many people do use personal loans to buy a car, but the issue is exacerbated by the strings attached to the money. Auto loans have amounts that are flexible enough to be used to cover nearly any type of vehicle, and in many cases the loan amount extended can be tailored specifically to the cost of the car chosen by the customer. This gives auto loans a major advantage, as you must only borrow exactly what is needed, without having to go deeper into debt.

Flexibility of Loan Types

Personal loans offer 2 financing options: fixed rate or variable rate. These have different advantages and drawbacks, but generally loans work in a similar way. Since personal loans are meant to be multi-purpose financing solutions, they are generally structured the same way, and are useful in some situations.

On the other hand, car loans come in all shapes and sizes, and offer different terms for new, pre-owned, and even vintage cars, simple rate loans and pre-computed loans which include interest and principal payment schedules from start to finish. You can even access various types of refinancing loans to improve your terms further, especially as your credit score improves over time. When it comes to purchasing a car, most situations are unique and provide different challenges. By taking a personal loan, you may be damaging your odds of favorable terms.

Personal Loans are Good, but Auto Loans are Better

Personal loans are an excellent solution if you need a quick financial boost. Because of their short terms and flexible loan amounts, they offer a multi-purpose financing solution that can cover many needs. However, many of the things that make them attractive also make them less suited to purchasing a car. Higher interest rates, shorter repayment terms, and lower amounts may mean they are not the ideal fit.

On the other hand, auto loans are designed specifically for vehicle purchases. You can take advantage of a variety of features, from more affordable and attractive interest rates to better probability of approval and more flexible loan amounts. When choosing your next loan, it’s important to research the best car loan options available to see which one best suits your needs.