To most of us, a loan is a loan; you borrow money, you spend it on what you need, you pay it back. That makes it easy to forget that a loan is a product, just like the things you buy at the store. And just like there’s a big difference between produce and candy, there are many differences between personal loans and car loans you should consider before taking out one or the other.
Personal Loans Vs. Car Loans
The most obvious difference is right in the name. A personal loan is just a transfer of funds to you from a lender that you can use for any purpose, while a car loan is specifically designed to purchase a car. But there’s more to this than just a name.
A personal loan tends to be “unsecured,” that is, the lender is giving you money on the assumption you’ll pay it back. As you might guess, like any act of trust, lenders tend to err on the side of caution with personal loans, and your credit rating can have a real impact. If your credit is less than perfect, you might see high interest rates, possibly in the double digits, and you may not be able to secure a loan at all.
If you do secure a personal loan, there’s going to be a very hard limit on how much you can borrow, no matter how great your credit is. You’ll also need to explain exactly why you’re borrowing the money.
Car loans are an entirely different matter. They’re “secured” because you’re using them to buy a specific asset, namely your car. Remember, technically speaking, a car loan means the lender buys the car for you, and holds the title while you pay back the loan. If a borrower takes out a car loan and doesn’t pay it, the bank can repossess the car and sell it, guaranteeing them that they won’t lose the entirety of the loan.
It rarely comes to that point, of course, which is another point in the favor of car loans: People need their cars, and thus will make their car payments on time. That security means you’ll also see lower interest rates, and that even if you’re still cleaning up your credit thanks to a family setback or a period of unemployment, you’ll have a much easier time getting the loan, and getting one for more money.
Finally, that lower level of risk means you’ll have more options for lenders. Personal loans are risky for lenders compared to car loans, and that means they vastly prefer to give you a loan for a car.
Which Should You Choose?
As a rule of thumb, when buying a car, you should choose the car loan. It’s simply going to be cheaper, less paperwork, less aggravation, and easier for you to secure. It’s true that with a car loan you don’t technically “own” your car until the loan is paid, but the higher interest rates of a personal loan mean you’ll pay much more, potentially thousands, for a piece of paper. In some cases, like buying a junker you’ll rebuild or buying a classic car, a personal loan will make sense or even be your only option. But if you’re buying a car to get to work and drop your children off at school? A car loan is going to make much more financial sense.