Personal Loans vs. Auto Loans: Explained
Posted by Frank Gogol in Loans | Updated on May 30, 2023
If you want to purchase a car, there are several options you can explore. The most common comparison is car loans vs personal loans. Read on to learn which might be best for your needs.
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Personal Loans vs. Auto Loans
If you are specifically trying to buy a car, you may be considering several financing options. Personal loans and auto loans are two leading ways people finance the purchase of used or new automobiles.
What is a Personal Loan?
A personal loan is money you borrow from a lender and receive as a lump sum. The lender charges interest and the loan must be repaid on a schedule. This schedule is called the repayment period.
Personal loans are usually unsecured, although secured personal loans also exist. You can spend the funds from a personal loan as you see fit.
People often get personal loans to cover expenses such as:
- large medical bills
- fixed price home or auto repair bills
- small business start-up capital
- debt consolidation.
Personal Loan Interest Rates
Personal loans are almost always unsecured. With no collateral, lenders manage the risk of making a loss by charging much higher interest rates than a similar secured loan. Generally, the only way to get favorable interest rates on personal loans is to have an excellent credit score and no history of defaults. It also helps if you have a high income.
Personal Loan Pros and Cons
Personal loans are a popular financing tool for many purposes. A few of the benefits and disadvantages of using personal loans are listed below.
Some of the advantages of personal loans are:
- Flexibility: You can spend the funds on whatever you want.
- Repayment: Many personal loan lenders allow you to choose long or short-term repayment schedules to suit your needs.
It is also important to keep in mind some of the disadvantages of personal loans, such as:
- Interest: Interest rates for unsecured personal loans are usually high unless you have excellent credit.
- Requirements: Many lenders impose minimum requirements for your credit score and income. If you do not meet them, the lender will reject your application.
- Credit: Your credit score determines how expensive lending will be. If you have bad credit, a personal loan can be much more expensive for you than for someone with a high credit score.
Personal Loan Terms
Many lenders offer flexibility in the repayment schedule of a personal loan. You can choose a short repayment period which results in savings on accrued interest in exchange for high monthly payments. Alternatively, you can choose a longer period which decreases your monthly payment but is more expensive in total due to accrued interest.
What is an Auto Loan?
An auto loan is a lump sum of money that you borrow from a lender to buy a car. The lender charges interest and the loan must be repaid on a schedule. Auto loans are secured with the car you are buying as collateral.
Auto Loan Interest Rates
Secured loans usually have significantly lower interest than unsecured ones. This is because the lender can sell the collateral to recover its losses if you default on the loan. Thus, the lender is willing to charge less interest because it has a lower long-term financial risk.
Auto Loan Pros and Cons
When it comes to financing the purchase of a car, auto loans are a very common tool. The benefits and disadvantages of this financial tool are listed below.
Some of the advantages of auto loans include:
- Interest: Auto loans, being secured, generally have lower interest rates than personal loans.
- Requirements: Credit score and other requirements for auto loans are often much less strict than for unsecured personal loans.
- Convenience: Auto loans are often available “on-the-spot” from vehicle dealerships.
It is also important to keep in mind some of the disadvantages of auto loans, such as:
- Ownership: You only get the title of the car after you have repaid the loan in full. You cannot sell the car without the lender’s permission.
- Deposit: Auto loans often require a deposit, which covers a percentage of the car’s total value. If you do not have a lot of cash on hand, this can be inconvenient.
- Predatory: Many buy-here-pay-here style auto dealerships offer on-the-spot financing at unfavorable, predatory terms, which can trap people into perpetual cycles of repayment and interest accrual.
Auto Loan Terms
Auto loan repayment terms are usually fixed industry-wide at 36, 48, 60, or 72 months. As with other loans, shorter terms require higher monthly payments but result in savings on interest.
There are many different lenders for auto loans, so it is important to compare different ones to find the best for your needs. Your car dealership’s financing offer may not be the best one. Investigate your local banks and credit unions as well.
Be very careful not to agree to predatory lending terms at a buy-here-pay-here used car lot. It can be very difficult and expensive to get out from under a predatory auto loan.
Auto Loan or Personal Loan: Which is Better
When comparing personal loans vs auto loans, there is no way to state which is better in all cases. Each is more useful in different situations. The considerations listed below will help you choose between personal loans vs auto loans for your financing needs.
- Type: For buying anything other than a standard automobile, an auto loan is unsuitable. You can only use an auto loan to buy a car.
- Age: If the car you want to buy is brand new, many manufacturers offer favorable dealer financing terms. An auto loan might be a good idea in this case. On the other hand, many lenders have age limits for financing used cars. If you want to finance a car older than 5 or 7 years, you may have to rely on a personal loan.
- Credit: Auto loans have lower requirements, so you might be better served by applying for an auto loan instead of a personal loan if you have bad credit.
- Collateral: If losing your car would have disastrous effects on your life or income, and your finances are precarious, it might be better to finance it with a personal rather than an auto loan. Then, if you default on the loan, your credit score will be affected but you will still be able to use the vehicle. Otherwise, if you default on an auto loan and the lender repossesses your vehicle, you could end up in a financial spiral.
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When comparing personal loans vs auto loans, the decision depends on your circumstances and needs. If you have poor credit, you are more likely to get approval for an auto loan. If there is some risk you could default on the loan and you do not want to lose the vehicle, a personal loan will protect the car from being seized as collateral. Generally, auto loans are easier to apply for and charge lower interest rates than personal loans.