Buying a Car: Car Loan vs. Personal Loan

March 2, 2021

When it comes to funding a car purchase, you have the option of applying for a personal loan or a car loan. But which one is right for you? While both can help you cover the cost of buying a car when you don’t have the funds available to buy outright – to then allow you to repay that cost over a period that suits you – each loan is quite different to the other.

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In this post, we’ll look at each type of loan in turn, to then discuss the differences between them, and why you might choose a personal loan or a car loan depending on your situation.

What is a Personal Loan?

Typically very flexible, personal loans can be used to fund pretty much anything. You could apply for a personal loan to upgrade your kitchen or add a deck to the yard. You could use a personal loan to organise the trip of a lifetime, to pay for your big day, or to cover a large vet bill, perhaps. Want to consolidate your debt? A personal loan could make that happen too.

While there are usually restrictions on what you can’t use a personal loan for – such as tax bills and business associated spending – for the most part, lenders are open to funding most types of purchases with their personal loans.

Personal loans offer plenty of flexibility elsewhere too. Depending on the loan, you could choose a repayment term over one to seven years, with the option to make your repayments weekly, fortnightly or monthly. You also have the option to choose between a variable or fixed rate.

It should be noted that personal loans can also be secured or unsecured. For the purpose of comparison however, we will discuss unsecured personal loans only in this post.

Q. Do you have to tell the lender what the personal loan will be used for?

A. That depends on the lender. Some may not ask at all, while others will want more detail. While it’s unlikely you will need to provide an in-depth run-down of where each dollar will be spent, you may have to give the lender a rough outline. As an example, you might tell the lender the loan will be used to cover the costs of your wedding and honeymoon, or renovations to your home.

With that being said, even if the lender doesn’t ask for details of what you plan to use the loan for, it may be written in the small print that you cannot use the loan for certain purposes, such as those mentioned above. By signing the loan contract, you are agreeing to those conditions.

What is a Car Loan?

As the name suggests, car loans are designed specifically to cover the cost of buying a car. So, unlike personal loans, which can be used for any number of different types of purchases, car loans are dedicated loans that can only be used to cover the cost of buying a car, and in some cases, the cost of related expenses, such as licensing and registration.

Like personal loans, car loans can be secured or unsecured – but, you will usually find they are secured. For that reason, we’ll focus on secured car loans in this post.

Again, depending on the lender, you can find car loans offered over one to five years, and in some cases up to seven years. Repayment frequency and loan amount will also depend on the lender, but you may only borrow up to the value of the car (plus any allowable extras), according to your credit and ability to repay.

In terms of interest, car loans often feature a fixed rate, although variable rate car loans are available. With a fixed rate comes a certain amount of inflexibility, such as an inability to make extra repayments or repay the loan early without penalty, but this will depend on both the loan and the lender.

Going Green?

If you’re thinking of buying an environmentally friendly car, such as an electric car or hybrid, you may be able to apply for a green car loan or personal loan to fund the purchase. These loans are designed specifically to fund ‘green’ purchases, rewarding borrowers with lower rates and waived fees. To find out more about green personal loans and car loans, check out this post.

What’s the Difference?

Okay, now time to compare the two. What sets personal loans apart from car loans? And what makes car loans different from personal loans?

Secured vs. Unsecured

While this is not always the case, you will usually find car loans are secured, while personal loans are unsecured. That essentially means with a secured car loan, the loan is secured against the car being purchased. Meanwhile, with an unsecured personal loan, no asset is required to place against the loan as collateral.

Cost

As you repay your loan, you will pay interest on each repayment at a rate set by the lender. How much the lender chooses to apply in interest is determined, in part, by the risk on the loan. While this will depend on your risk ‘rating’ as a borrower – based on your creditworthiness – it will also depend on the risk rating of the loan.

From the lender’s perspective, a secured loan is lower risk. Why? If the borrower fails to repay the loan, the lender has the right to repossess the secured asset – in this case, the car – in order to recoup any lost costs. To reward the borrower for this lower risk status, the lender will typically offer a lower interest rate on its secured loans than its unsecured loans.

How does that affect you? The rate applied to your loan not only affects the affordability of your repayments, it also affects how much you will pay back overall on your loan. Let’s take a look.

Connor wants to apply for a loan of $20,000 to buy a car. He looks at a secured car loan with a rate of 6% p.a. and an unsecured personal loan with a rate of 10% p.a.Repaying the loan over five years, his repayments would be $387 per month on the secured car loan, or $425 on the unsecured personal loan.

His overall interest cost on the secured loan would be $3,199, and $5,496 on the unsecured personal loan.

By choosing the secured car loan, he would pay $47 per month less in repayments (or $564 less per year), and he would save $2,297 overall in interest.

Ease of Approval

As another side effect of that lower risk status, secured car loans can be easier to get approved for than unsecured personal loans. With no asset placed against the loan to reduce the risk for the lender, unsecured loans typically require applicants to have excellent credit. Meanwhile, you may get away with middling credit on a secured car loan, as long as you meet all other eligibility requirements – and you can prove your ability to repay the loan.

Loan Purpose

As we mentioned before, car loans can only be used to fund the purchase of a car (or other approved vehicles), while personal loans can be used for almost any purpose. This obviously makes personal loans a lot more flexible, allowing you to choose exactly what you want to spend your loan funds on.

With a personal loan, you could choose to cover the cost of not only buying a car, but the funds you will need to make upgrades to it. This could make it a worthy option for someone buying a car as a project. Alternatively, you could borrow a little extra to cover the costs of running the car, such as stamp duty, registration, car insurance, and running and maintenance costs.

TIP. While there are personal loans and some car loans that allow you to borrow extra to cover running costs, you may want to consider the true cost of adding that on to your loan. By increasing your loan amount, you will pay more in interest, especially when you stretch the loan over a longer period, to take longer to pay it back.

Time to Apply

With that flexibility in loan purpose, it’s also worth pointing out that when you apply for an unsecured personal loan, you will typically need to provide less info to the lender during the application process with regards to what the loan will be used for.

With a secured loan, on the other hand, the lender will need full details of the car you are buying, and may charge a security fee to secure the asset to the loan.

Conditions & Restrictions

While we’ve already covered flexibility of loan purpose, let’s look now at the restrictions imposed on both loan types. With an unsecured personal loan, there are very few restrictions placed on borrowers – although it’s always a good idea to check the small print carefully to make sure of that before you apply.

On the other hand, borrowers applying for a car loan may face any number of restrictions. These are mostly based around the car being purchased. As an example, if you’re buying a used car, the car may need to be under a certain age either at the time of approval, or at the end of the proposed loan term.

Lenders may also restrict loans on imported car purchases, on purchases made via a private seller, and on the purchase of vehicles that have previously been written off.

Loan Term

When you apply for a loan, you choose the loan term – or repayment period – in which you want to repay what you owe. With a longer loan term, you can stretch out your loan, making your repayments more manageable (while typically increasing the amount you pay back in interest). With a shorter loan term, you can pay off your loan faster, while paying less in interest.

With personal loans, you will find most offer loan terms over one to seven years. So, if you want to borrow less – or you have the capacity to pay higher repayments on a larger loan amount – you can pay off your loan quicker. Alternatively, if you need more breathing space within your repayment schedule, you can increase your loan term on the other end of the scale.

With car loans, you may find slightly less choice with regards to loan terms. While there certainly are car loans out there offered over one to seven years, there are others that restrict terms to three to five years. If you only want to borrow a small amount, this will either restrict your options, or stretch out your loan so you pay more than you should in interest.

Credit Provider

As you compare personal loans and car loans, one thing you will likely notice is the vast array of lenders in the mix. For both types of loan, you will see any number of lenders touting their wares, with options from traditional bricks and mortar institutions that you know well, as well as online providers you’ve probably never heard of.

While there are pros and cons to each of those options, there is a third choice when you opt for a car loan over a personal loan. This is dealer finance.

Dealer finance – as you might suspect from the name – is financed offered by the dealer when you buy a car from a dealership. How does dealer finance work? Dealers that offer finance have a relationship with a preferred bank or credit provider, which allows them to arrange finance on your behalf when you buy a car.

But, is dealer finance the right option for you? Here are some pros and cons.

  • It takes the hassle out of applying. You tell the dealer how much you can afford to repay each month and the dealer does the rest. All you need to do is sign on the dotted line.
  • The dealer will make it happen. The dealer stands to gain commission on both the sale of the car and the loan, so they will pull out all the stops to make sure you get approved for finance.
  • You could get approved with bad credit. Again, the dealer wants your sale, and may offer finance packages designed for buyers with poor credit history to open up more sales avenues.
  • You don’t know how the loan compares within the market. The dealer only goes through one credit provider, which means the loan they offer is the loan you get. Unless you do your own research – and read the small print on the loan carefully – you may end up with a loan that doesn’t suit your needs.
  • It could cost you more. In the same vein, you may end up paying more on your loan with a higher rate. Or you may end up paying more overall if the dealer has marked up your monthly payment to put aside a little more profit for themselves.
  • You may feel a sense of obligation to the dealer. It’s easy to get swept up in the car buying process, especially when the dealer puts the car and finance in such an effortless package. You may feel obliged to say yes – especially if the dealer is a great salesperson.

Credit of Funds

When you are approved for a personal loan, the lender will usually credit the funds to a nominated account. This allows you to use the funds as and when needed. If you opt for a secured car loan and buy from a dealer, the funds will typically be directed to the dealer on approval, so you won’t access them at all.

Flexibility

The flexibility – or inflexibility – of a loan is typically determined by the type of interest applied to it. While there are lenders that offer full flexibility in both their variable and fixed rate loans, you will usually find loans with a variable rate are generally more flexible than loans with a fixed rate. Let’s find out why.

  • With a fixed rate (often found on secured car loans), the rate remains the same throughout the loan term. As such, the repayment schedule is also fixed, so the repayment amount stays the same, month in, month out. While this can make for easier budgeting, it may also mean you can’t make extra repayments or pay off the loan early without facing – often quite considerable – fees and other costs.
  • With a variable rate (often found on unsecured personal loans), the rate may fluctuate according to market conditions and the lender. Variable rate loans often allow borrowers to make extra repayments and pay off the loan early without penalty. Extra repayments may be accessed via a redraw facility, when needed.

Why Use a Personal Loan?

Now we’ve highlighted the differences between the two types of loan, let’s take a look at why you might choose one type of loan over the other. First up, under what circumstances might it be better to choose a personal loan?

  • When you want more freedom. Whether you’re not exactly sure which car you want to buy, or the car you’re interested in doesn’t fit the lender’s mould of what’s deemed acceptable as security, you may choose a personal loan to enjoy a bit more freedom in what you can buy.
  • When you want to buy a car privately. While you can find car loans that allow for private sales, you may choose a personal loan simply for the broader scope of what the loan can be used for.
  • When you are buying a project. Not everyone buys a car as a runaround. Some people buy cars as projects, either to restore or upgrade in some way. Choosing a personal loan can allow you to fund the initial cost of purchasing the car, with the option to borrow a bit more to cover the planned upgrades as well.
  • When you want to borrow more. While some car loans allow you to tack on more to cover costs such as stamp duty and registration, a personal loan would offer a bit more wiggle room, allowing you to borrow as much as you need to cover everyday running costs, should you need that.
  • When you don’t want to secure your car. With an unsecured loan, you don’t have to use your new car as security. That means, if your situation changes and you can’t repay the loan, the lender cannot simply repossess the car to pay off their losses. With that being said, you would still face serious consequences for failing to meet the terms of your loan contract if you can’t repay your loan.
  • When you want more flexibility. If you opt for a personal loan with a variable rate, you may enjoy any number of flexible features, giving you the opportunity to make extra repayments and repay the loan early – to pay less in interest on the loan – or take advantage of redraw when you need it.

Things to Remember

  • If you’re applying for an unsecured personal loan, the lender will usually require you to have good credit.
  • If your personal loan has a variable rate, know that the rate you’re approved for may go up or down over the life of the loan.

Why Use a Car Loan?

And now, why you might choose a car loan over a personal loan.

  • When you want a lower rate. By securing your car against the loan, you will usually be rewarded with a lower rate. This should provide you with a lower repayment amount, and a lower overall interest cost.
  • When you know which car you want to buy. You know what car you want to buy, and it meets the lender’s restrictions.
  • When your credit is less than perfect. If your credit could do with some improvement, you may find it easier to get approved for a secured car loan, as the security placed against the loan helps to lower the risk for the lender.
  • When you want to get preapproval. When you get preapproval on a car loan, you know how much you can borrow and you can negotiate accordingly.

Things to Remember

  • If you opt for a car loan, you may have the option to make a balloon payment at the end of the loan term. While this can lower the cost of your repayments, be aware that you will have to cover that large balloon payment at the end of the term, plus any interest that’s accrued on it.
  • While we have focused on secured car loans with fixed rates, there are unsecured options out there, with some offering variable rates. It pays to compare the market – or let Credit World do the hard work for you.

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