Although car loans are actually a type of personal loan, there are some minor differences between the two products. When it comes to buying a car, whether you choose to apply for a car loan or a personal loan will depend on a number of factors.
Pros and cons of a car loan
A car loan is usually a secured personal loan. The car itself is used as security for the loan, so you want to make sure that you don’t miss any repayments and find your set of wheels has been repossessed. It is possible to find car loans that are unsecured, although they tend to come with higher interest rates.
While some car finance comes with variable interest rates, most car loans feature fixed rates. One of the benefits of a fixed rate is that it makes the ability to budget easier, as you’ll know your exact repayments over the term of the loan, for example between one and five years.
The downside to a fixed rate is that it doesn’t offer any flexibility in regards to repayments. If you suddenly come into some money and want to pay off your loan entirely, you may have to pay an early termination fee.
Pros and cons of personal loans
A personal loan allows you to borrow for a wider variety of purposes, while car loans are usually restricted to only motor vehicles. You can use a personal loan for things like financing a holiday, a car, home renovations, or consolidating your debts.
Because of this extra range of purposes, personal loans come with a greater range of options:
- Fixed rate
- Variable rate
The benefit of being able to choose a secured loan is that they usually offer lower rates, because they are secured against an asset and are therefore a lower credit risk for the lender.
The borrowing sum to think on
NZ’s government-funded Sorted offers a good way of looking at borrowing money for a car. They suggest the main puzzle pieces you need to get into place when you’re borrowing money for a car are:
How much you pay = loan amount + interest and fees + repayment time
If anything on the right side of the equation goes up (the amount we borrow, the add-ons, or how long we take to pay it back) then so do our overall costs. The idea is to keep all three as low as possible.
The first two make sense: if we borrow more, we have more to pay back; if interest rates are higher or set-up fees rise, we also have to pay back more. But time often trips us up: for example, if we choose to pay off our car over a longer period, our costs seem to go down. We have less to pay back every month, and those lower bills feel more manageable. For example, using Canstar’s Personal Loan/Car Loan Calculator:
$25,000 loan at 15% over 3 years = $867 a month
$25,000 loan at 15% over 5 years = $595 a month
In reality, while it may be a smaller amount to pay back each month, by increasing the term of your loan you’ve also increased the number of repayments you’ll have to shell out. It’s something to think about.
$25,000 loan at 15% over 3 years = $31,199 total cost
$25,000 loan at 15% over 5 years = $35,685 total cost
The bottom line for consumers
By saying that a car loan is a type of personal loan, it’s like comparing green apples to red apples – they are both types of apples that can help you buy a car. 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 needs. That decision essentially requires asking yourself a few easy questions:
- Do you want a fixed rate or variable rate loan?
- Would you prefer to have a secured or unsecured loan?
- How long do you want the loan to last?
- Would your budget do better with a lower interest rate, or flexible repayment options?
- Are you looking to repay the loan early and having the personal loan more as a cash flow tool?
- Do you want to modify your car? It can be costly to make modifications to your car, whether that be a coat of paint or as extensive as changing the body of the vehicle. Some car lenders won’t let you add this cost onto your loan. With a personal loan, you can borrow however much you like, so you can add this cost to the loan amount yourself. You will also need to consider the insurance implications if you’re modifying your purchase.
Like with any financial decisions, research your options thoroughly. One of the most effective ways to compare loans is by looking at specific options side by side. You can compare personal loans easily with Canstar by hitting the button below:
Sign up to receive more insights like this straight to your inbox.
Enjoy reading this article?
Sign up to receive more news like this straight to your inbox.