When deciding between a personal vs. car loan, there are some things you should consider. We will help you to make a decision by explaining the differences between both loan types.

Auto Financing With a Car Loan

You have been shopping around for weeks and now you have set your heart on the perfect new car. The next question is: How will you pay for it?

Buying a car is one of the biggest investments you can make. With many cars priced at five figures, it is easy to wonder just how you will pay for such a large purchase. When faced with the matter of paying for your next car, you may wonder if a personal loan or car loan is the best option to choose.

What is a Car Loan?

A car loan is a loan used to purchase a vehicle. The auto loan is secured against the vehicle being purchased, making it collateral. The lender maintains ownership of the vehicle until the borrower makes the final payment. If you default on your loan payments, the lender may seize the vehicle.

Understanding Personal Loans

An unsecured personal loan is a loan made by a bank or lending institution that gives the borrower a lump sum for a certain amount. This sum may be used at the borrower’s discretion and can be used for major purchases or to pay off debt. Personal loans generally range from $1,000 to $50,000.

A secured personal loan is secured against a valuable item such as a house or a car. If you are unable to repay the loan, the lender may seize your asset to recoup their losses. Most personal loans are unsecured loans.

So the bottom line is: Auto loans can only be contracted when buying a car. As they are using the vehicle as collateral, they are secured loans. Personal loans on the other hand can be used for any major purchase. Most of them are secured, too, but there are unsecured ones as well.

However, both options affect your credit score — hence, we will take a look at that next.

Personal Loan vs. Car Loan: How Your Credit Score Factors

Most lenders use credit scores to describe a potential borrower’s creditworthiness. On one side, they are defined by the borrower’s credit history. On the other side, credit scores are also a powerful tool for the decision to get a loan at all or to determine your interest rate.

Both car loans and personal loans have interest rates based on your credit history. Personal loans typically have higher interest rates than auto loans, sometimes as high as 29%. If you have bad credit, you may find it more beneficial to work to improve your credit score than being stuck with a high annual percentage rate (APR) on a personal or car loan.

Having bad credit can also make it harder to qualify for auto financing from either a lender or a dealership. In this case, you may need to take out a secured or unsecured personal loan. Like a car loan, defaulting on a secured loan could make you lose the title to your vehicle. With unsecured credit, you could be able to keep the title to your car should you default, but you still risk facing collections.

Using a Personal Loan to Buy a Car

The different ways for car financing may look quite similar, so let us take a closer look at the details:

1. Credit History

Personal loans and auto loans both offer favorable terms for borrowers with good credit. However, borrowers with credit scores below 580 may not be approved for a personal loan or may require a cosigner. You can still be approved for a car loan with poor credit as the lender could be able to repossess the vehicle if you default on the loan.

2. Interest Rates, Fees, and Other Charges

Personal loans generally require borrowers to pay origination fees to cover the underwriting of the loan. While they typically do not come with any origination fees, car loans may sometimes come with prepayment penalties. Both personal and car loans come with annual percentage rates (APR), so it is important to shop around for the right loan if you are considering either one for a car purchase.

3. Timeframe

Most car loans are typically offered at fixed 36 to 60-month terms, while personal loans usually have repayment periods starting at 12 months. With car loans and personal loans, longer loan terms offer lower monthly payments, but with more interest paid over the life of the loan.

Why Choose a Personal Loan for Auto Financing?

Compared to an auto loan, paying for your new car with a personal loan can have many advantages:

  • Most of them are offered without any limitations to what the funds can be used for.
  • A personal loan may offer you the convenience and flexibility of an unrestricted lump sum.
  • They can be offered by banks, credit unions, and online lenders.
  • Repayment Terms: Personal loans have set monthly payments made over several years.

While dealer-financed car loans may be more convenient for auto shoppers to obtain, personal loans may prove to be more effective for those with good credit or collateral to secure the loan. When shopping for a vehicle, you must do the proper research on all of your available financing options to determine which one is right for you.