Personal Loans vs Car Loans: Which is Better for You?

How they work and the pros and cons of each Part of the Series Personal Loan Guide Personal Loan Types

Personal loans and car loans are two common financing options for major purchases, but a car loan is often better for buying a car.

The main difference between a personal loan versus a car loan is that a personal loan is typically unsecured, meaning it has no collateral. An auto loan is usually backed by the car, so the lender has lower risk if you default on the loan. Auto loans generally have lower interest rates. A personal loan can be used for many different purposes, including buying a car, whereas a car loan is only for buying vehicles.

When it comes to financing a major purchase like a car, you have two main options a personal loan or an auto loan. Both allow you to spread out the cost over time, but they work differently. I’ll compare personal loans and car loans in depth so you can decide which is better for your situation

Overview of Personal Loans and Car Loans

A personal loan is an installment loan from a bank or online lender that you can use for nearly any purpose. Car loans are a specific type of installment loan used to finance a new or used car from an auto dealer or lender.

The main differences between personal loans and car loans include:

Purpose: Personal loans are flexible, while car loans can only be used for a vehicle purchase.
Collateral: Personal loans are usually unsecured. Car loans are secured by the vehicle you’re purchasing.
Interest rates: Car loans tend to have lower interest rates because they are secured.
Loan amounts: Both loans can range from $1,000 to $100,000.
Repayment term: Terms are typically 2 to 7 years for both loan types.

Now let’s take a deeper look at the pros and cons of each loan option.

Benefits of Personal Loans

Personal loans have a few key advantages over car loans

Flexible usage: You can use a personal loan for any purpose, including consolidating debt, home improvement projects, medical expenses, vacations, and more. With a car loan, you can only buy a vehicle.
No collateral required: Personal loans are usually unsecured, so you don’t have to use your car or home as collateral. This gives you more flexibility if you ever have trouble making payments.
Potentially faster funding: Personal loans can sometimes be funded in just 1-3 business days after approval. Car loans require you to find the exact vehicle you want and negotiate pricing.
Fixed rates and terms: Personal loan rates and terms are fixed, so your monthly payment stays the same. Car loans may have variable rates that could increase.
No prepayment penalties: Most personal loans allow you to pay off your balance early with no penalties. This isn’t always the case with car loans.

Benefits of Car Loans

However car loans also offer some perks

Lower interest rates: Car loan rates are often lower because the vehicle serves as collateral for the lender. Rates range from 3% to 20% for borrowers with good credit.
Dealer discounts or incentives: Dealers may offer discounted pricing or 0% APR deals when you finance with them directly. This can save you thousands over the loan term.
Insurance discounts: Most lenders require you to carry comprehensive and collision coverage on a financed vehicle. This qualifies you for multi-policy discounts from your insurer.
Build credit history: Responsibly paying your car loan can help you establish or rebuild your credit score over the loan term. This may help you qualify for better rates on future loans.
Auto expertise: Auto loan lenders have experience appraising vehicle values and structuring affordable payment terms. Dealers also handle all paperwork and DMV requirements.

As you can see, each loan has unique advantages depending on your financial situation and goals. The better option comes down to your specific borrowing needs.

Comparing Interest Rates on Personal Loans and Car Loans

The biggest factor in deciding between a personal loan or car loan is the interest rate you can qualify for. Here are some guidelines for rates based on your credit score:

Credit Score	Personal Loan APR	New Car Loan APR	Used Car Loan APR
760+ Excellent	5% to 15%	3% to 7%	4% to 8%
690-759 Good	10% to 20%	4% to 10%	6% to 12%
620-689 Fair	15% to 25%	8% to 16%	10% to 20%
580-619 Poor	20% to 30%	12% to 20%	14% to 24%
500-579 Very Poor	25% to 36%	16% to 24%	18% to 28%

As you can see, people with good credit (scores over 690) can qualify for much lower rates on a car loan, often saving 10% or more compared to a personal loan. The savings are smaller for those with fair credit and negligible for borrowers with very poor credit.

Before applying, get your credit report and FICO score to estimate your rate range. Then, compare personal loan and auto loan rates from multiple lenders. Apply with the lender offering the lowest APR for your situation.

Loan Amounts: How Much Can You Borrow?

Both personal loans and car loans come in loan amounts from $1,000 up to $100,000. The amount you can qualify to borrow depends mainly on:

Your income – Lenders want to see you earn enough to afford the monthly payments. Those with higher incomes can qualify for larger loan amounts.
Your existing debt – If you have high balances on other debts, it may limit the additional amount you can borrow.
Your credit history – Borrowers with higher credit scores are seen as lower risks and can get approved for larger loans.

For car loans, the value of the vehicle you want to buy also caps the amount you can borrow. Lenders rarely finance more than the car’s total value.

Pre-qualifying with multiple lenders gives you estimates on loan amount offers before formally applying. This helps ensure your loan request isn’t too high or low.

Repayment Term Lengths

Personal loans and car loans generally offer repayment terms between 2 and 7 years. Shorter terms have higher monthly payments but save on interest charges. Longer terms are easier to budget for but accrue more interest over time.

Here are some common loan term lengths and features:

2 to 3 years – Best for small loan amounts. Quicker to pay off. Lower total interest costs.
4 to 5 years – Good balance of affordable payments while paying down principal. A popular term length.
6 to 7 years – Lower payments but pays more interest over the long run. Common for larger loans.

Experts recommend a 3-year term on used cars and no more than 5 years for new cars. You also want to pick a term where you pay down a good chunk of the principal in the first couple years before the car depreciates significantly.

Aim to pay off personal loans in 3 years or less if possible. The savings on interest costs outweigh the benefit of lower payments over longer terms.

How to Apply for Personal Loans and Car Loans

The application process is similar for personal loans and auto loans. Here are the main steps:

1. Check your credit and scores. Know your credit profile before applying so you can predict your loan offers.

2. Research lenders and compare loan options. Evaluate which lenders offer the best rates and terms for your situation. Pre-qualify to estimate your actual offers.

3. Submit a loan application. Formally apply for your chosen loan. Be ready to provide income, employment, and identity documents.

4. Accept the loan offer. Carefully review the final loan agreement before signing. Make sure you understand the full terms and costs.

5. Receive your loan funds. Once approved, your loan funds will be sent directly to your bank account within 1 to 7 days.

To make the process easy, apply online through a lender’s secure website. This allows you to upload documents electronically and e-sign forms.

Alternatives to Consider

Personal loans and auto loans aren’t your only options for financing large expenses:

Home equity loan or line of credit – Leverage your home equity to get tax-deductible financing at low rates. Only for homeowners.
Business line of credit – Companies can access revolving credit lines to cover short-term cash flow gaps. Repayment is flexible based on your revenue streams.
401(k) or retirement plan loan – Borrow from your existing retirement savings. Interest goes back into your account but reduces your investable balance.
Credit cards – Reward cards and 0% APR offers provide short-term financing for smaller purchases. Easy to qualify but high rates on revolving balances.
Buy now, pay later plans – Allow you to split purchases into installments over 6 to 24 months. Only usable at participating retailers. Limited purchase amounts.
Cash purchases – If possible, avoiding financing costs by buying in cash from your savings. Give yourself time to save up.

Compare all your options to find the most affordable financing method for your situation and budget.

Which is Better: Personal Loan or Car Loan?

So when should you get a personal loan versus a car loan? Here are some key questions to help you decide:

Do you have good credit? Car loans have lower rates for well-qualified borrowers, saving substantially over a personal loan.
**Are you getting a special deal

personal loan vs car loan

Personal Loans

A personal loan provides you with funds from a lending institution like a bank in a lump sum. A benefit of this type of loan is that you can use the money at your discretion. Such spending can include paying for a vacation, wedding, or home improvement project.

Most personal loans are unsecured. However, a personal loan can be secured against an asset, such as a vehicle or home. If a personal loan is secured, the lender can seize your asset to recover its losses if you dont repay the loan.

You can use a personal loan calculator to determine how interest rates and loan terms will affect what youll pay for each month.

No restrictions on how funds are spent
Flexibility in payment structure (short versus long term)

Interest rates likely to be higher than on car loans
Tougher lending requirements
Consumers with poor credit scores likely won’t qualify

The Terms for Personal Loans

Personal loans have a set repayment period, such as 12 months or 36 months. Longer loan terms will lower your monthly repayment, but you’ll be paying more interest over the term of the loan. Conversely, shorter loan terms mean higher monthly repayments, but incur less interest overall, since you are paying off the principal faster.

Personal Loan Vs Car Loan: Which Is Better? | Mount Shine [2023]

FAQ

Is it better to get a personal or auto loan for a car?

Generally, it’s advisable to use an auto loan to finance the purchase of a car because these types of loans tend to have lower credit score requirements and offer lower interest rates.

Are personal loan rates higher than car loans?

Although interest rates vary for both loans, car loans are secured loans, which means they’ll generally have lower interest rates. On the other hand, personal loans generally have higher rates. That means the rate you qualify for can vary based on your credit score, debt-to-income ratio (DTI) and annual income.

Is it better to finance a car or loan from bank?

Key takeaways. Dealership car loans offer convenience, but you will likely find better deals on interest rates by getting a loan from a bank, credit union or online lender. To secure the best auto loan rate, whether at the dealership or elsewhere, it is essential to arrange financing ahead of going to the car lot.

Can I use a personal loan to pay off a car?

You can use a personal loan to pay off your car, but whether it’s a good idea will depend on your credit score and financial position. If you swap out your auto loan for an unsecured personal loan, your car will no longer serve as collateral.

Is a personal loan better than a car loan?

Personal loans are best for large, one-time expenses like debt consolidation or home improvement projects. You can use a personal loan to finance a new or used car, but an auto loan is likely the cheaper option. $1,000-$100,000. $5,000-$100,000. 6%-36%. 5%-28%. 2-7 years. 2-7 years. Can be, but unsecured is more common. Yes, by your vehicle.

What is the difference between personal loans and auto loans?

Personal loans and auto loans serve distinct purposes, each with advantages and considerations — and choosing between them depends on your financial goals and needs. While personal and auto loans may appear similar, they have striking differences. Personal loans are unsecured, meaning they don’t require collateral.

Why are interest rates higher on personal loans than auto loans?

Interest rates are usually higher on personal loans than auto loans. That’s because personal loans are unsecured and riskier for lenders. As of 2022, interest rates on personal loans were around 9.65%, almost twice as high as interest rates on auto loans (which were set at 4.95%).

Can you use a personal loan to finance a new car?

You can use personal loans for almost any type of expense, including financing a new car. Personal loans generally come with higher interest rates than auto loans because personal loans are unsecured vs. secured. While you typically don’t need to make a down payment, your lender may charge an origination fee.