Personal Loans vs. Car Loans: What's the Difference? (2024)

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.

Key Takeaways

A personal loan can be used for many different purposes, whereas a car loan is strictly for purchasing a vehicle.
A personal loan can be secured with an asset, but it is more commonly unsecured.
A car loan is secured with the vehicle you purchase, so it can be repossessed in the event of a default.
Both car loans and personal loans are generally fixed-rate installment loans that have set terms and regular monthly payments.

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 don't repay the loan.

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

Pros

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

Cons

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

How Interest Rates Work on Personal Loans

Generally, unsecured loans have higher interest rates than comparable secured loans with collateral. Unsecured personal loans also come with more stringent approval requirements, so you’ll need credit if you want lower rates. If your credit history is poor, you may not get approved for a personal loan.

Your credit score will influence both the loan amount and the interest rate. The better your credit score, the more likely you are to qualify for larger loans with lower interest rates.

Interest rates on personal loans are generally fixed, but personal loans can also have variable interest rates.

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.

Car Loans

A car loan is secured with the vehicle you purchase. If you default on your repayments, the lender can seize your car to try to recoup its losses. Much like with a mortgage, the lender retains ownership over the asset until you make the final payment.

Car loans are paid off in fixed monthly installments with varying terms and interest rates. One common car loan term is five years.

Try using an auto loan calculator to determine what interest rate and loan term would best suit your needs. With these tools, you can estimate monthly payments and ensure they would fit into your budget.

Interest Rates

Given that the lender has the collateral of the car backing the loan, the loan is considered lower risk. So, you will generally get a lower interest rate than you would on a personal loan. Interest rates are also fixed, so you will know what to expect with your monthly payments.

Pros

Usually a lower interest rate than on a personal loan
Easier to get with mediocre credit history
Often offered at dealerships
Fixed payments offer predictability

Cons

You don’t have title to the car until the final repayment is made
A deposit may be required to secure the loan
You can only use a car loan to buy a car

The Terms

Car loans are often fixed at 36, 48, 60, or 72 months. Other term lengths are possible as well. And like the personal loan, the shorter the term, the higher the monthly repayment and vice versa. A less-than-average credit history won’t necessarily prevent you from getting a car loan.

There are a variety of ways to get car loans. Before signing up for a dealer loan, shop around for car loans from your bank or credit union, which can often give you better deals.

Can You Use a Personal Loan to Buy a Car?

If you get a large enough personal loan, you can use it to buy a car, since funds from a personal loan can be used for any purpose. However, you can likely get much lower interest rates on an auto loan.

Is it Better to Get a Personal Loan to Pay for a Car?

Generally, it's better to get an auto loan to pay for a car because they typically have lower interest rates. Because your car serves as collateral for a loan, lenders consider the loan a lower risk. Lower interest rates save you money in the long-term. If you can get a personal loan with a lower interest rate than a car loan, it may be better to get a personal loan to pay for a car.

How Long Does it Take to Get a Personal Loan?

You can typically get a personal loan within one to five business days. In some cases, you can apply online and receive the funding the same day. Applying for a personal loan is a straightforward process. You can fill out an application online or at a bank branch.

The Bottom Line

When it comes to buying a new car, you have several financing options. Go beyond a dealership's financing offer and shop around for various loans to ensure you get the best interest rate. In most cases, an auto loan that uses your car as collateral will provide the lowest interest rates. But explore your options in using personal loans as well.