Auto Loans Vs. Personal Loans: Which is Better?

If you're in the market for a car, you might be exploring various financing options. Personal loans and auto loans are among the top choices for financing the purchase of new or used vehicles.

Both options can be beneficial depending on your circumstances. In this blog, we'll explore the difference between these personal loans and auto loans.

 

What is an auto loan?

An auto loan is essentially a lump sum borrowed from a lender to finance a car purchase. As the loan is tied to acquiring an asset – the car, it falls under the category of secured loans since there's an asset securing it.

Since your car serves as collateral, this implies that if you miss payments or default on the loan, the lender has the right to repossess your car to recover their losses.

Due to the assurance that the lender will recover their funds, it's considered less risky for them to provide the loan. This reduced risk translates into lower interest rates for you, leading to potential savings over the loan's duration.

Requirements to secure an auto loan

Because auto loans are secured by collateral, they are typically easier to qualify for, even if your credit score isn't perfect. You might be eligible for an auto loan with a low credit score, depending on factors like your debt-to-income ratio and the size of your down payment.

Read: How to improve your credit score

Interest rate

Interest rates on secured loans are typically much lower compared to unsecured loans. The reason behind this is that the lender can sell the collateral to cover their losses in case of a default. Therefore, the lender is inclined to offer lower interest rates as they face lower long-term financial risk.

Down payment

When obtaining a car loan, you may have to provide a down payment. While some dealerships might offer zero-down options for both new and used cars, this could lead to a higher interest rate. While down payment requirements can vary, aiming to put down 20% of the car's cost typically results in a more favorable interest rate.

Length of loan

Although longer car loans have become more popular lately, the most common loan lengths typically range from 60 to 72 months. In some cases, car loans can extend as far as 96 months.

Read: Short-term vs. Long-term Car Loans: Which is Better?

Type of car

Car financing puts restrictions on the kind of car you can purchase. Lenders have cutoff points for how old a car can be in order to finance it. It also generally has to be in working condition. Generally, new cars and used cars less than 10 years old are the ones commonly financed. This financing is usually available through dealerships or directly through financial institutions like credit unions or banks. 

Ownership of the car

When you take out a car loan, the lender retains ownership of the car's title until you've paid off the loan completely. You'll only receive the title once the loan is fully repaid. Without the lender's approval, you can’t sell the car.

 

What is a personal loan?

Personal loans are a type of loan you can use for various personal needs, including buying a car, but not limited to them. You have the freedom to use the money from a personal loan as you wish.

There are two types of personal loans: secured and unsecured. Secured loans require valuable assets like a car title as security. If you can't repay, the lender takes the asset. Unsecured loans don't need collateral but have higher interest rates because they're riskier for lenders. 

To get lower interest rates, it helps to have a great credit score, no history of missed payments, and a high income.

Requirements to secure a personal loan

Typically, having a credit score of 670 or higher is necessary to qualify for a personal loan. Lenders also assess your income to ensure you can manage the loan payments. 

Interest rate

Personal loans typically come with higher interest rates, and the rate you're eligible for depends on factors such as your credit score, debt-to-income ratio (DTI), and annual income. Having a poor or bad credit score can make it challenging to secure a personal loan.

Down payment

Personal loans don't typically require any upfront payment. When you apply for a personal loan, your lender provides you with a single lump-sum payment. However, your lender might charge an origination fee to cover the administrative expenses of setting up your loan.

Length of loan

Personal loans come with a structured repayment plan typically measured in months. Lenders often offer flexible repayment schedules, allowing you to select either long or short-term plans based on your preferences. 

For most borrowers, loan terms ranging from 2 to 7 years are common, although some lenders provide even longer options. Remember, the duration of your loan impacts the total interest you'll pay. Opting for a longer-term loan results in paying more interest over time.

Type of car

Personal loans offer greater flexibility when it comes to the type of car you purchase since you can use the funds for almost any purpose. With a personal loan, you have the freedom to buy any car you desire. This loan can streamline the process of purchasing a car directly from an individual or even enable you to buy a vintage car at an auction.

Ownership of the car

Personal loans do not demand collateral. This means you don't have to worry about your car being repossessed if you miss payments or fail to pay on time.

 

Bottomline

Sometimes, you need a loan for big purchases, but choosing the right type can be tricky. Personal loans don't have specific rules, but they depend on your credit score. The better your score, the better the loan you'll get. Car loans are only for buying cars. They're not as concerned about your credit score; they focus more on the car's price. So, even with a low credit score, you could still get a decent car loan. But remember, with car loans, the lender owns your car until you pay off the loan.