Personal loan or car loan: Finding the right financing option for your car

Purchasing a car is a significant decision, and once you make up your mind, you begin an exciting journey to find the perfect vehicle for yourself. You test drive cars, take recommendations from friends and family, make quick comparisons, and ultimately select the ideal car. However, one crucial aspect of this journey is deciding on the best financing option. While many Filipinos may opt for a car loan, some may suggest a personal loan as an alternative. This article will guide you through the differences between personal and car loans, helping you decide when to finance your car. Let's begin!

Also Read: When and why to refinance your car loan

Personal loans

A personal loan is a sum borrowed from a financial institution, such as a bank, credit union, or online lender that can be utilized for various personal needs. These needs may include buying a car, consolidating debt, financing home improvements, or paying for unexpected expenses. Unlike specific loans like car loans or home loans, which are secured by the asset being purchased, personal loans are usually unsecured, meaning they don't require collateral. You receive a lump sum of money upfront and repay it over time with interest, typically in fixed monthly installments.

Key features

• There are no restrictions on how the funds are used. Once you get the amount, you can utilize it. However you want (go on a fancy vacation or finance your dream wedding), unlike other loans like a car loan or home loan, which are meant to be used for a defined purpose.
• A personal loan is an unsecured loan, which means you don’t keep any collateral as a security against the money borrowed.
• Generally, unsecured loans, like personal loans, attract higher interest rates than compared to secured loans.
• Personal loans are usually fixed-rate installment loans with a pre-decided term, like 1-year, 3-years, 5-years, and regular monthly payments.

Pros and cons of using a personal loan for financing your car

Car loans

A car loan, also known as a vehicle or auto loan, is a specialized loan wherein the borrower receives money from a lender, like a bank or credit union, to pay for the car. The loan is secured, and the car acts as the collateral. So, if payments are missed, the lender can take possession of the vehicle. Car loans usually have a fixed interest rate and a repayment schedule, requiring regular monthly payments until the loan is fully paid off. This type of loan allows people to purchase a car without paying the entire amount upfront, ultimately making car ownership more feasible.

Key features

• It's a secured loan backed by the vehicle itself, serving as collateral.
• The loan amount is directly transferred to the dealer/seller’s account. This disbursed amount can only be used to finance the chosen car.
• The interest rate for car loans is on the lower side, generally ranging between 9.5% to 11.5% (effective interest rate)
• Most car loans are designed for new cars; however, one can opt for a car loan for a used car as well, depending upon the make and model of the car. Please note that car loans for used cars attract a higher interest rate than new car loans.
• You have to pay the down payment, which is 20-30% of the car's cost, out of your own pocket. The lender covers the rest. No lender covers 100% of the car's price.

Pros and cons of using a car loan for financing your car

Factors to consider when choosing between personal loan and car loan

1. Interest rates: Personal loans typically have higher interest rates than car loans. Since car loans are secured by the vehicle itself, they generally offer lower interest rates. Consider the total cost over the loan term to determine which option saves you more money in interest payments.
2. Loan term: Personal loans often have shorter terms than car loans. A shorter loan term means higher monthly payments but less interest paid overall. Conversely, car loans typically offer longer terms, spreading out the payments and potentially reducing monthly expenses, albeit with higher interest costs in the long run.
   
3. Purpose of the loan: If you need funds specifically to purchase a car, a car loan may be more suitable due to potential lower interest rates and specialized terms. However, if you require funds for various purposes beyond buying a car, a personal loan offers flexibility as you can use it for any expense.
4. Credit score: Your credit score influences the interest rates and terms you're eligible for. Generally, individuals with higher credit scores receive better loan terms. If you have a strong credit score, you might qualify for favorable rates on either type of loan. However, if your credit score is lower, you may face higher interest rates or stricter terms, making one option more advantageous.
5. Collateral: Car loans are secured by the vehicle itself, meaning the lender can repossess the car if you default on payments. This reduces the lender's risk, often resulting in lower interest rates. Personal loans are typically unsecured, meaning they don't require collateral. If you're unable to repay a personal loan, there's no specific asset for the lender to seize. However, this higher risk for the lender usually translates to higher interest rates for you as the borrower.

Bottom line

Generally, it's more advantageous to opt for a car loan as they offer lower interest rates than personal loans. Ultimately, lower interest rates mean more savings in the long run. However, if you manage to get a personal loan with a lower interest rate than an auto loan, then that may be the way to go. The bottom line is always do your research and weigh your options before making a decision.

Also Read: How to budget for your car loan repayment effectively