Car loans and personal loans are considered two (2) popular consumer finance options in Australia. And if you have both options available to purchase a car, it can be tricky to know which one to use!
By understanding the difference between the two (2), you’ll hopefully be in a better position to choose the right option for your needs. Read on to find out more about what you need to know.
What is a personal loan?
You can use a personal loan for just about any personal purpose deemed acceptable by the lender, including:
- going on a holiday;
- covering the cost of a wedding;
- debt consolidation (combining all your debts into one loan);
- buying a car;
- vehicle repairs; and
- small home improvements.
Personal loans can be secured or unsecured loans and vary in loan amounts and loan terms, depending on the lender and what is available to you. With an unsecured loan, you don’t need to provide an asset as security for the finance.
You will usually need to have a good credit score (also called a credit rating) to be approved for an unsecured personal loan. If yours is low, there are steps you may be able to take to help improve your credit score.
As the name suggests, a car loan is specifically for buying (or repairing) a new or used car, unlike a personal loan that can be used for a broader range of purposes (including buying a car).
Car loans are usually secured loans. This means that the car you are buying is generally used as security for the finance. If you don’t repay your secured car loan, your lender may be able to legally repossess and sell your vehicle to recover the amount you owe. You will then generally only be entitled to the remaining sales proceeds (if any).
If you happen to have a bad credit score, it’s possible to get a car loan for bad credit — just because your credit has taken a hit in the past, doesn’t mean it should impact your future!
Unsecured personal loans tend to have higher interest rates than secured car loans. That’s because unsecured loans are generally riskier for the lender. If the borrower doesn’t make their repayments in accordance with the loan agreement, it can sometimes be harder for the lender to get their funds back. With a secured car loan, the lender may be able to repossess and sell your car if you don’t make your repayments pursuant to your credit contract.
You will generally see two rates advertised on both car and personal loans. One rate (usually the lower of the two) is the interest rate. The other rate (which may be higher) is called the ‘comparison rate’. It shows the interest rate plus the cost of any fees expressed as a percentage.
It can be a good idea to always use the comparison rate when comparing different loan options. Generally, you should choose the option with the lowest comparison rate, provided you meet the eligibility criteria, and it has all the features you need. For example, if you have a bad credit rating, you may not have the luxury of choosing from different loans. In that case, look for finance that suits your needs, satisfies your cost requirements and where you suitability meet all of the eligibility criteria.
Differences between car loan and personal loan terms
The ‘term’ of a loan is the timeframe you have to pay it back.
Standard personal loan terms in Australia are generally between one (1) and 10 years. Standard car finance terms are between one (1) and seven (7) years.
If you want to lower your regular repayments, you may be able to take out a longer loan term (and vice versa). However, it’s important to understand that you may pay more interest if you have a longer loan term.
You have to make regular repayments on both personal and car loans in accordance with the loan agreement. The repayments are usually monthly direct debits, but you may be able to arrange for weekly or fortnightly repayments if you prefer. It can be a good idea to align your repayments with when you get paid to help make budgeting easier.
Your repayment amount will generally depend on:
- how much you borrow;
- the interest rates (which can be fixed or variable);
- any ongoing fees;
- the frequency of your repayments;
- your loan term; and
- whether you include a balloon payment if you’re taking out vehicle finance.
Fixed and variable interest rates
Variable interest rates can move up or down during the life of the finance. Fixed interest rates, on the other hand, stay the same.
Variable interest rates move up or down based on market interest rate movements. If interest rates increase and you have a variable interest rate on your loan, your repayments will increase. If interest rates happen to decrease, you’ll likely enjoy cheaper repayments.
If you have a fixed interest rate, your repayments will stay the same throughout the life of the loan. This can sometimes make it easier to budget for your contractual repayments as the repayments remain consistent and certain for the life of the loan.
Whether you have an unsecured or secured loan, you’ll generally be able to choose from a fixed or variable rate.
Car finance vs personal loans: the pros and cons
Below is a summary of what we think are some of the main pros and cons of car finance vs personal loans.
Car loan pros & cons
- It can only be used for purchasing a vehicle. If you’re looking to use the funds to buy a car, this isn’t really a con at all!
- Your lender may be able to repossess and sell your vehicle if you don’t make your secured car loan repayments in accordance with your loan agreement. This could be seen as an advantage because your other assets may not be on the line.
Personal Loan pros & cons
- It can be used for a wider range of purposes than purchasing a vehicle.
- Your lender will likely not be able to repossess and sell any of your assets if you take out an unsecured personal loan and you don’t make your repayments. However, it is important to note that they can take legal action against you, so you can’t simply walk away from your obligations.
- Unsecured loans typically have higher interest rates than secured car loans.
- It can be very difficult to get an unsecured loan if you have a bad credit score.
- Using a personal loan to buy a car can be excessively expensive.