Personal Loan vs Car Loan | What’s the Difference?

Are you interested in getting a loan but aren’t sure which one to go with? Personal loans and car loans are two popular options, although there are key differences between them. Before you decide on either one, we encourage you to stick around.

In this guide, we discuss the features that make each loan unique and when it’s best to use them. If you have any questions about securing a loan that will meet your needs or you’d like some assistance with financing your goals, contact our loan specialists today. We are always happy to lend a helping hand. 

Let’s begin by defining personal loans and car loans before transitioning to discussing their purposes. 

Personal Loans vs Car Loans

Most of us have run into financial difficulties at some point in our lives. Whether our vehicle broke down and needed repairs, or we fell ill and had an unexpected medical bill, life tends to throw curveballs at the most inopportune times. 

When these difficulties arise, they can really put our bank account in a headlock. Fortunately, there are options available that can pull us out of our slump and get our finances back on track. 

We’re talking about personal loans.

A personal loan is designed to let you take care of a costly, one-time expense. If you are currently faced with a financial burden that has put you in a bind, you might want to consider taking out a personal loan to help you survive this challenging time.

While you can certainly use a personal loan to finance a new or used vehicle, you’re usually better off sticking with a car loan for such purposes. This is because personal loans are unsecured, meaning you’ll have to pay back higher interest rates.

Car loans are secured by the very vehicle you’re buying, thus resulting in lower rates. The big difference here, however, is that you’ll likely need to provide a down payment.

Financing a Vehicle With Either Loan

Car loans are almost always going to be the cheapest way to finance a new or used vehicle. While it’s true that some dealerships and lenders might let you finance without a down payment, you will get a much lower rate on your loan if you go ahead and provide one.

Auto refinancing loans come in handy when you want to buy out a car lease. Moreover, you might be able to get a lower rate by refinancing. You will, however, need to have made on-time payments on your car loan for a year or more, and your credit will need to have improved.

Personal loans, on the other hand, generally work best if you don’t want to put a down payment on the vehicle and don’t mind accepting a higher rate in exchange for unsecured funds. Furthermore, choosing a personal loan ensures that the lender won’t be placing a lien on your vehicle. This means that you will have your clear title in-hand if you decide to sell your car before it’s paid off.

Rates

Now comes the discussion of rates. Annual percentage rates (APRs) on personal loans are often higher than those of auto loan rates. This is because the lender is taking on a greater risk by letting you borrow money without your vehicle serving as leverage.

When you get a car loan, your rate is affected by the type of vehicle you buy. Furthermore, loans taken out for a used car will often come with a higher APR than a new car loan.

But that’s not all that dictates the rate you’ll receive with your loan. Regardless of whether you take out a personal loan or a car loan, lenders will look at your current credit report, income, and any existing debts to determine what your interest rate will be.

To ensure that your interest rate is low, you’ll need to have a FICO credit score of 690 or higher (good to excellent, respectively), have little if any debt, and bring in reliable income. 

As you can see, a lot influences what you’ll ultimately pay back to the lender. Therefore, it would be prudent to work toward restoring or building your credit now if it isn’t in the best shape. There are many things you can do to help improve your credit score.

Check for Errors

The first thing you should do is check your credit report to see if it has any errors. If you find something in question, you have a right to dispute it. This includes missing information. Make sure that you contact the credit reporting agency, as well as your lender, to let them know.

Pay on Time

Secondly, get into the habit of paying your bills on time if you aren’t already. This is one of the single best things you can do to improve your credit score. While this won’t resolve past late or non-payments, you can still make a difference in the here and now.

It’s important to remember that poor credit history can only haunt you forever if you let it. Take action and work hard to get your payments back on track. When you establish a good history of payment patterns, past credit problems fade away over time.

Also, keep in mind that paying off a bill that’s gone to collections won’t remove it from your credit report. It’s going to be there for seven years, which is why it’s so important to improve other areas as best you can.

Get Help

If you’re struggling to meet all of your financial obligations, let your creditors know. You might also want to seek the advice of a qualified credit counselor to help you manage your money. As you improve your money management, your credit score will likely improve, as well.

Reduce Your Debt

Getting your debt squared away is equally important and will play a big role in improving your credit report. If you currently rely on credit cards for much of your spending, work to reverse this by keeping your credit card balances low.

Many people make the mistake of moving debt from one credit card to another. But you can effectively improve your credit score by paying off your debt instead. If you can help it, don’t open new credit cards in an attempt to raise your score, as doing this often has a negative effect.

Terms

Lastly, you need to consider your repayment terms for either loan option. Car loans typically come with terms that last between two and seven years, whereas personal loans often have terms of three to five years. Some lenders will allow personal loans of seven years, but it’s uncommon.

Most buyers who use a car loan will usually opt for a term of five to seven years. While it might initially seem appealing to go with a longer term, you have to remember that you’ll be paying more interest in doing so.

It’s best to keep your term at five years or less to ensure that you end up paying a reasonable amount for your vehicle. This will also ensure that you aren’t in debt any longer than you need to be. 

Getting Your Loan

Regardless of which loan option you choose, the process for getting it is going to be about the same. The first step is to check your credit score. Knowing what you’re dealing with ahead of time will make it easier to determine your interest rate.

Then, compare several lenders to see who offers the best one for your financial needs. Use a free online loan calculator to see what you can afford to pay and then proceed to apply. 

Some lenders will let you apply for prequalification first, which doesn’t require a hard credit check and won’t affect your credit score. If you’re approved, there’s a good chance that you’ll qualify for the actual loan offer, as well (although it’s not always a guarantee).

Please bear in mind that a hard credit check is performed to determine whether you qualify for the actual loan, so your credit score will take a hit when this is done. 

When you get the loan offer, make sure that you read over its terms carefully before agreeing to anything. You want to be sure that you understand it completely, so take your time and don’t be afraid to ask questions.

When you are satisfied with the terms and interest rate and are confident in the loan, sign it and buy your new or used vehicle!

Summary

We hope this guide helped you gain a better understanding of your loan options. If you have any questions about loans or need help securing one, don’t hesitate to reach out to us. In the meantime, be sure to explore the rest of our blog page for more helpful tips.

 

Sources

https://www.consumerfinance.gov/ask-cfpb/what-is-the-difference-between-an-interest-rate-and-the-annual-percentage-rate-apr-in-an-auto-loan-en-733/

https://www.myfico.com/credit-education/improve-your-credit-score

https://www.cnbc.com/select/hard-inquiries-credit-score/

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