Car loans vs personal loans: pros and cons

If you’re buying a car and need to get a loan, you may be wondering which is best – a car loan or personal loan?

Although car loans are a type of personal loan, there are subtle differences between the two products. We’ll explore common pros and cons of each to help you work out which is the right option for you.

Key differences between car loans and personal loans

The first key difference between a car loan and a personal loan is that a car loan is usually secured, where the car itself is used as security for the loan. As such, car loans are typically for new or near new cars. You can get an unsecured car loan, but it will often have a much higher rate of interest because of the increased risk for a lender.

A personal loan allows you to borrow money for a wider variety of purposes, like financing a holiday, a car, home renovations, or consolidating your debts. While you may need to specify what the purchase is for – in this case, buying a car – you might be able to borrow more than the car costs and use extra funds for another purchase or to boost your cash flow (provided you can meet the repayments). Loans can be unsecured or secured, and come with a fixed rate or a variable rate.

Pros and cons of car loans

If you’re exploring new car loans to help buy your car, then it’s likely your car will be secured against the loan amount using collateral. Or, you could take out an unsecured car loan. Here are some pros and cons for secured car loans:

Pros:

• They typically attract lower interest rates than unsecured personal loans
• They often come with fixed rates, giving you more certainty about meeting repayments for the life of the loan
• You may be able to borrow a higher sum than with an unsecured car loan, depending on your circumstances

Cons:

• You might be restricted on the type of car you can purchase (e.g. new or near new only)
• You could lose the car or other collateral if you can’t meet repayments
• Fixed rate loan terms and fees can be less flexible, especially regarding extra or early repayments (e.g. if you won the Lotto tomorrow and wanted to pay off the rest of your loan, you might have to pay an early termination fee)

While it is possible to find variable rates and unsecured car loans, they might not be as common, so shopping around could be a good idea.

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What about car dealership loans?

Car dealerships can also offer new car financing. If you explore this option, you may find some dealers offering appealing interest rates (some as low as 0%), but be mindful of the terms and conditions, such as balloon payments. Moneysmart suggests shopping around for a car loan before going to a car dealership to make sure you’re getting the best deal available to you, potentially saving thousands in interest and fees.

As you can see, car loan products can vary significantly between lenders. So, it’s important to take the time to compare specific fees, interest rates, features and conditions to work out what’s right for your needs.

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Pros and cons of personal loans

If you’re thinking about getting a personal loan to buy a car, the main differences are likely to be that the loan is unsecured and that you can use the loan for different expenses. Here are a few potential pros and cons of an unsecured personal loan to consider:

Pros:

• Flexibility to buy a new or old car
• Possibility to borrow and use extra funds to boost your cashflow or make another purchase
• Flexibility to choose loan terms that best suit your needs, like secured or unsecured, variable or fixed interest rates
• If your personal loan is unsecured, you won’t automatically lose the car if you’re unable to make repayments

Cons:

• Unsecured personal loans tend to attract higher interest rates and fees
• Lenders might rely more heavily on the borrower’s finances, such as their income and credit score, to determine borrowing power
• If a borrower can’t meet their repayments, the lender can take you to court to recover the money

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Car loan or personal loan to buy a car – which is best?

Ultimately, a car loan is a type of personal loan, and both car loans and personal loans can help you buy a car, so one is not necessarily better.

What that means for you is that it’s less about pros and cons, and more about looking for the right product to suit your personal needs. You might find it helpful to ask yourself a few questions:

1. Are you buying a new or older car?
2. Would you prefer to have a secured or unsecured loan?
3. Will your credit score affect your borrowing capacity?
4. How much can you afford to pay over the loan term?
5. Would a lower interest rate, or flexible repayment options be preferable with your budget?
6. Are you looking to repay the loan early and have a personal loan as a cashflow tool?

To help you understand what products may be available, you can check out Canstar’s Personal and Car Loan Star Ratings to compare loans based on price and features.

Does your credit score matter with getting a car or personal loan?

Your credit score could matter with your decision making about getting a car loan or a personal loan. Keep in mind if you have a poor credit score, you may find it more difficult to get a loan approved compared to someone with a good credit score. A low credit score could also make it harder to get a low interest rate for the loan, as the lender could see you as a risky borrower. If you do get approved for a loan and make repayments regularly and on time, this could help your credit score over the longer term, but if you get repeatedly rejected for loans, this could get reported on your credit report and potentially influence your credit score.

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Cover image source: Stokkete/Shutterstock.com

This updated article was originally written by Kelly Stone

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