What’s the difference between a personal loan and a car loan?

It’s worth taking the time to understand the differences so that you can choose the loan that best suits your unique life circumstances. 

Two key differences

A car loan is actually a special type of personal loan, but there are two key differences between them. 

Firstly, a personal loan can be used to pay for almost anything, from a car or holiday to dental work or school fees. A car loan, as the name suggests, is specifically designed for the purchase of a car. 

The second key difference is that a personal loan can be secured against something of value, but it’s more likely to be unsecured. An unsecured loan means if you’re unable to make repayments down the track, the lender won’t seize your valuable assets (such as a property or jewellery) to cover the costs. 

A car loan, on the other hand, is generally secured against the vehicle you intend to purchase. If you’re unable to make the repayments on your loan, the lender has the right to seize the car and sell it to make up the shortfall on the loan. 

It’s worth weighing up the pros and cons of both loan types to decide which is the best option for your budget.

Pros and cons of a personal loan

Personal loans are usually more flexible than a car loan because they allow you to borrow for a wider variety of purposes. When selecting a personal loan, you can choose between an unsecured or secured loan, a fixed or variable interest rate, and a shorter or longer loan term. 

Personal loans sometimes come with the option to make additional repayments so that you can repay the loan early or redraw from the extra funds to make other purchases. 

Unsecured personal loans tend to be more common than secured personal loans, but the downside is they come with a higher interest rate. This is because the lender views them as more of a gamble than a secured loan, so they apply a higher interest rate to offset the risk.  

To qualify for an unsecured personal loan, your lender will want to make sure you have a good credit history and a solid income so you can repay the loan without falling into financial difficulty. 

A car loan is generally secured against the vehicle you are purchasing. This means if you miss your repayments or default on the loan, your car will be in the firing line. The lender has the right to repossess the car and sell it to cover the cost of the loan.

With your car acting as collateral for the loan, your lender will view the loan as lower risk which generally means they’ll apply a reduced interest rate. A secured loan also comes with fewer lending requirements, making it easier for people with an average credit history. 

Most car loans come with a fixed interest rate. This means you’ll be protected from market fluctuations and can easily budget as the repayments never change throughout the life of the loan. On the downside, a secured car loan with a fixed interest rate usually doesn’t come with the flexibility to make additional repayments or pay the loan back early. 

Some lenders will offer unsecured car loans with variable interest rates, but these are less common. 

So, which one is right for me, if I’m buying a car?

When it comes to choosing between a personal loan and a car loan, there’s no one-size-fits-all. There’s no doubt that obtaining a car loan is generally swift and convenient. But before you put your foot on the accelerator (see what we did there?) it’s worth taking the time to ask yourself these questions:

  • Is my financial situation going to change over the life of the loan?

If you know your income and expenses will remain largely unchanged in the coming years, you might decide to go with a car loan so you can take advantage of the fixed repayments. However, if you’re planning some big life events, such as buying a home or getting married, you might be better off with a personal loan with more flexible terms. This could mean you choose higher repayments for the first couple of years and then go back to minimum repayments when you’re navigating some significant life changes. 

  • Have I chosen the car?

When you apply for a car loan, you may need to provide the details of the car, including the make, model and VIN number. If you’d rather have the funds in the bank before you go car shopping, a personal loan might be a better option. But remember, you can always apply for pre-approval on a car loan. This doesn’t guarantee you a loan but gives you an idea of what the lender is willing to lend you once you’ve chosen your car. 

  • Do I have collateral for a secured personal loan?

If you want a secured personal loan with a lower interest rate, you’ll need to provide an asset as collateral. This could be your home, another vehicle or any other valuable item. 

  • Is my credit score healthy?

If you have a mediocre credit score or you know there are some black marks on your financial report card, you could be better off applying for a car loan. Lenders consider car loans to be less risky because the car is used as collateral against the loan. This means that even borrowers with average or poor credit scores can find a lender who’s willing to offer them a chance. 

Applying all the pros and cons to your individual financial situation means you can move forward  knowing you’ve made the best choice for your budget.

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