How They Differ

If you’re in the market for a major purchase like a new car, or need some extra cash to fund a personal project, taking out a loan could be your best bet.

Personal loans and car loans represent two of the most common financing options. Assuming you meet their respective lending requirements, they can be relatively easy to obtain. These days, most lenders accept online applications for personal loans, and car loans are generally approved on the spot at the car dealership.

So what’s the difference between the two? A personal loan can be used for many different purposes, whereas a car loan (as the name implies) is strictly for the purpose of purchasing a vehicle. If you want to borrow money for a car, you could simply take out a car loan, but if you require funding for a purpose that’s less specific or falls outside the typical lending box (such as a vacation, wedding or home improvement), a personal loan provides more flexibility.

Each loan type bears its own pros and cons, so it’s important to weigh and compare them before signing on the dotted line.

The Personal Loan (Unsecured)

A personal loan provides the borrower with funds from a lending institution (generally a bank), whereby the full loan amount is paid in a lump sum that can be used at the borrower’s discretion. Personal loan amounts typically range anywhere from $1,000 to $50,000.

A personal loan can be secured against something of value, such as a vehicle or home, allowing the lender can seize your asset to recover its losses in the event that you don’t repay the loan. However, most people opt for an “unsecured” personal loan, which means the loan is free from collateral.

Interest Rates

Generally, unsecured loans have higher interest rates than comparable secured loans with collateral attached. Unsecured personal loans also come with much more stringent approval requirements, so you’ll want excellent credit on your side. If yours is in poor shape, a personal loan might not be an option – that is, until you can strengthen it (see 3 Easy Ways To Improve Your Credit Score). Both the loan amount and the interest rate (which can be fixed or variable) will be largely influenced by your credit rating. The better your credit rating, the higher your borrowing capacity and the lower your interest rate. Conversely, the poorer your credit rating, the lower your borrowing capacity and the higher the rate.

The Terms

Personal loans have a set repayment period, stated in months (e.g. 12, 34, 36). Longer loan terms will lower your monthly repayment, but you’ll be paying more interest over the term of the loan. Conversely, shorter loan terms mean higher monthly repayments, but incur less interest overall, since you are paying off the principal faster.