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

A personal loan is an unsecured loan that can be used to pay for just about any large expense. An auto loan is different because it's a secured loan used exclusively for the purchase of a new or new-to-you vehicle.

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 Takeaways

• Personal loans and auto loans differ mainly in collateral and flexibility: Personal loans are unsecured and can fund almost any expense, while auto loans are secured by the vehicle being purchased, which generally results in lower interest rates.

• Auto loans tend to cost significantly less for vehicle purchases: On a $40,000 loan at typical rates, the lower APR on a secured auto loan can save more than $9,000 in total interest over five years compared to a personal loan.

• An auto loan is the better choice for most buyers if you can qualify: Lower rates often mean lower monthly payments. A personal loan makes sense if you can't qualify for auto financing or want to buy a private-party or older vehicle that most auto lenders won't finance.

Summary generated by AI, verified by MoneyLion editors

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Personal Loans vs. Auto Loans: Key Differences

What Is a Personal Loan?

A personal loan allows you to borrow money and pay it back in monthly payments over a term of two to seven years, with interest.

There are different types of personal loans that can be used for nearly any type of expense, including:

• Debt consolidation

• Home improvement

• General expenses like a vacation or wedding

Personal loans are available from banks, credit unions and online lenders. Most are unsecured, which means the lender won't require you to put up an asset in case you can't pay. However, unsecured loans can come with higher interest rates.

What Is an Auto Loan?

An auto loan is essentially a personal loan to buy a car. It's money you borrow for the sole purpose of purchasing a vehicle. Rather than receiving a lump sum of cash like with a regular loan, with an auto loan money goes directly to the car dealer.

• The loan amount includes the purchase price of the car, minus your down payment, which many lenders require, plus any interest and fees.

• This loan is considered secured because it uses the financed car as collateral.

• If you're unable to make payments, the lender can repossess your car to protect itself from financial loss. Because of this, auto loans can have lower interest rates than personal loans.

Lenders often restrict the types of vehicles you can finance with an auto loan. Many won’t loan you money for a commercial vehicle, for example, or for a car that’s older than 10 years or that has more than a certain number of miles on it. Cars that lack a clear title are also restricted because the title is what secures the auto loan.

Auto loans are also different from auto repair loans. The latter are typically smaller, often unsecured personal loans used to pay for unexpected maintenance or fixing a car you already own.

How To Apply for a Personal Loan vs. 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.

How To Apply 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 drive 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. Gather the information and documents you’ll need before you start your application. They include a government-issued photo ID, Social Security number, proof of address and proof of employment and income.

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

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

6. When you're ready, complete the loan application. You could receive instant or near-instant approval.

7. Read the loan offer carefully. If you agree with the terms, follow the lender’s instructions for accepting and finalizing the loan.

8. Provide a bank account number to receive the loan funds. You should have the money in a few days or even less.

9. 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.

How To Apply 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.

3. Comparison-shop for auto loans from your car dealer, your bank, a local credit union and online lenders. Request rate quotes from each.

4. Gather the information and documents you’ll need for your application: government-issued photo ID, Social Security number, proof of address and proof of employment and income.

5. Have the vehicle VIN number and your auto insurance information ready when you apply.

6. Complete and submit the loan application. You could be approved the same day.

7. Review the terms of the loan carefully. Follow the lender’s or dealer’s instructions for accepting the loan.

8. Although the loan can take several days to finalize, you might be able to drive the car home as soon as you’ve completed the purchase and loan documents.

When To Choose a Personal Loan vs. Auto Loan

An auto loan is usually, but not always, the best way to finance a car purchase.

Choose a Personal Loan If

• You don’t have cash to buy a car outright

• You don’t qualify for an auto loan

• You don’t want to risk losing your vehicle if you fall behind on your payments

Choose an Auto Loan If

• You’re comfortable putting the car up for collateral

The Bottom Line

A personal loan gives you flexibility and no collateral on the line, while an auto loan gives you a lower rate because your car backs the debt. The right pick comes down to what you’re buying and how much risk you want to carry. If you’re buying a car, an auto loan almost always costs less. If you need cash for something else or want to skip the collateral, a personal loan could fit better. You may also want to weight how a personal loan vs. credit card compare if you're looking for flexibility.

FAQs

Is a personal loan or an auto loan better for buying a car?

An auto loan is usually the better choice because the car acts as collateral, which typically means a lower interest rate. A personal loan makes more sense if you want to skip the collateral or the car is too old to qualify.

Does an auto loan have a lower interest rate than a personal loan?

In most cases, yes. An auto loan is secured by your vehicle, so lenders take on less risk and tend to offer lower rates than an unsecured personal loan.

Is a personal loan or auto loan easier to qualify for?

It depends on your credit and income. Auto loans can be easier to get since the vehicle secures the debt, while personal loans often require a stronger credit profile for the best rates.

Can I use a personal loan to buy a car?

Yes. A personal loan can cover a car purchase and the lender doesn’t hold the title, but you’ll likely pay a higher interest rate than you would with an auto loan.

Key Terms

• Secured loan: A loan backed by collateral, for an auto loan, the vehicle itself. Because the lender can repossess the asset if you default, secured loans typically carry lower interest rates than unsecured loans.

• Unsecured loan: A loan that doesn't require collateral. Personal loans are typically unsecured, so approval depends on your creditworthiness and income rather than an asset you pledge.

• Annual percentage rate (APR): The yearly cost of borrowing, expressed as a percentage, including the interest rate and certain fees. It's the most useful number for comparing loan offers side by side.

• Collateral: An asset pledged to secure a loan. With an auto loan, the vehicle serves as collateral; with most personal loans, no collateral is required.

• Down payment: An upfront cash payment that reduces the amount you need to finance. Many auto lenders require a down payment; personal loans typically don't.

Summary generated by AI, verified by MoneyLion editors

Sources

• Consumer Financial Protection Bureau: What is a credit card interest rate? What does APR mean?

• Consumer Financial Protection Bureau: What is a credit score?

• Consumer Reports: How to Spot and Avoid Unnecessary Car-Buying Fees

Dawn Allcot contributed to the reporting for this article.

Photo credit: Prostock-Studio / iStock.com