Personal Loan vs. Auto Loan: What's the Difference?

A personal loan is an unsecured loan that can be used to pay for a large expense like a home improvement. An auto loan is different because it's a secured loan used exclusively for the purchase of a new or new-to-you, late-model car with relatively low mileage.

If you're looking to finance the purchase of a car, you may be comparing the terms and rates of personal loans and auto loans. Here's what you need to know before you submit your loan application.

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Key Differences Between Personal Loans and Auto Loans

What Is a Personal Loan?

A personal loan allows you to borrow money and pay it back in monthly payments over a term of one to 10 years, with interest. The money will be deposited directly into your account. Sometimes called an installment loan, personal loans are available from banks, credit unions and online lenders.

It's an unsecured loan because the lender doesn't require you to put up an asset in case you can't pay. Unsecured loans are generally considered more risky, so interest rates can be higher.

There are different types of personal loans that can be used for various expenses, including:

• Debt consolidation

• Home improvement

• General expenses like paying for a vacation or wedding

Some loan terms will prevent you from using a personal loan to buy a car.

What Is an Auto Loan?

An auto loan is money you borrow for the sole purpose of purchasing a vehicle. The loan amount will include the purchase price of the car — minus any down payment — plus any interest and fees. The loan money will go directly to the car dealer.

This loan is considered a secured loan because the car you bought is used as collateral. If you're unable to make payments, the lender can repossess your car to protect themselves from financial loss. Because of this, auto loans can have lower interest rates than personal loans. Most lenders will also require a down payment.

You may be able to roll taxes, registration and title costs into the loan or pay them as part of the down payment, depending on your lender.

How To Apply for a Personal Loan or Auto Loan

The process of applying for a personal loan or auto loan is similar. However, you may need a higher credit score to secure the best rates on a personal loan, since it's not backed by collateral.

Applying for a Personal Loan

When you're applying for a personal loan, it's good to keep the following in mind:

1. Check your credit reports and fix any errors that could be driving your credit score down.

2. Try to keep your credit utilization as low as possible — ideally 30% or less — when you prepare to apply for the loan.

3. Determine how much money you'll need to borrow. Then, compare rates by getting prequalified through several lenders.

4. You might consider checking rates at a bank, a credit union and an online lender.

5. When you're ready, complete the loan application. You should receive the money in a few days or even less.

6. Set up automatic loan payments through your bank. Some lenders will even offer a rate discount if you provide a bank account for monthly direct debits.

Applying for an Auto Loan

You'll typically apply for an auto loan after you've chosen your vehicle. Take a look at this overview below:

1. Calculate your loan amount based on the cost of the vehicle, including any taxes, titles and fees if you're including them in the loan amount.

2. Subtract your down payment. A personal loan doesn't require a down payment.

3. Compare auto loan rates with your dealer, your bank, a local credit union and online lenders.

4. Lenders will want you to provide the vehicle's VIN and your auto insurance information, along with all the personal information you'd need to provide for a personal loan.

5. Once you've found a lender and are approved, the funds will go straight to the car dealer. You'll make monthly payments to your lender.

How Long Does Approval Take?

• Personal loans: It can take anywhere from the same day to a several days, depending on the lender.

• Auto loans: Approval times may vary from a few minutes if at a dealership. In other cases, it may be a week or more, according to SoFi.

Where Can You Apply?

• Personal loans: Banks, credit unions or online lenders

• Auto loans: Banks, credit unions, online lenders or at the dealership where you're purchasing the vehicle.

Tips To Boost Your Approval Odds

To boost your odds of approval for either a personal loan or an auto loan:

• Ensure you can afford the loan payments — this is a key consideration for lenders.

• Check your credit reports before you apply and fix any errors.

• If you have high-interest debt, try to pay it down.

• Avoid opening any new accounts while you're preparing to apply for a loan.

Pros and Cons of Each Option

Let's explore the pros and cons of a personal loan and a car loan so you can make the best decision for your situation.

Personal Loan Pros

• No collateral required

• No down payment

• Use the money for any purpose

Personal Loan Cons

• Potentially higher interest rates

• May require a good credit score to secure the best rates

• Some personal loans come with application or origination fees

• Some lenders won't allow you to use a personal loan for a car

Auto Loan Pros

• May come with an APR as low as 0%

• May be easier to qualify for

• Money paid directly to car dealer

Auto Loan Cons

• Lender holds the title to your vehicle

• May require gap insurance and full collision coverage

• May require a down payment, including taxes, titles and fee

How To Decide Which Type of Loan Is Better?

For many people, an auto loan is the best financing option for buying a car. The down payment and collateral often offer cheaper interest rates that will save you money while you're paying it off.

However, if you don't want to put your car up as collateral or you don't have a downpayment, a personal loan is a good alternative. Because some lenders don't allow financing of cars through personal loans — and you're required to tell the lender what expense you're financing — you may have trouble finding a lender. A personal loan may also be more expensive in the long run because unsecured loans have higher interest rates.

FAQs

Which one is easier to get: a personal loan or auto loan?

An auto loan may be easier to get, since it's often a secured loan backed by your vehicle as collateral.

Does a personal loan or auto loan have lower interest rates?

Secured auto loans typically have lower interest rates than personal loans. Buyers with excellent credit may even qualify for 0% financing through a car dealer.

Can I use either a personal loan or auto loan for buying a vehicle?

Yes, you can use a personal loan or auto loan to buy a car.

How do they affect credit score?

Personal loans and auto loans are both installment loans that will affect your credit. Your score will dip when you apply for a loan, and again when you open the new loan account. On-time payments of your car loan or personal loan, over time, will boost your credit score.

Can I switch from a personal loan to an auto loan, or vice versa, later?

If you take out an auto loan, you can take out a personal loan to pay off your car loan at a later date if you find you can secure a lower interest rate. However, if you take out a car loan, it can't be used to repay a personal loan — it can only be used to purchase that vehicle.

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