Personal Loan or Car Loan—Know The Difference

A person buying a new car on credit is often faced with a question as to which loan to seek – a personal loan or a car loan? An answer to this would primarily rest on the requirement of an individual.

While car loans are specifically designed to fund a new car buying, like any other secured loans there are certain factors that may weigh on the decision of the borrowers. Let us first understand both the loans.

What Is A Personal Loan?

A personal loan is an unsecured loan, which means it doesn’t require a collateral. It carries a rate of interest higher than secured loans such as a car loan or a home loan. Also, the interest rate on personal loans varies for individuals, and is largely based on the CIBIL score and the credit report.

The personal loan can be used for any legitimate purpose and can be a viable option in a variety of circumstances, such as a vacation, paying off debt, medical expenses, wedding expenses, and for buying consumer goods.

What Is A Car Loan?

A car loan is a secured loan and is taken to buy a new four-wheeler. It has a lower interest rate. Car loans are secured, which means they are backed by a lien on the underlying asset—the car itself. A lien is a legal claim that allows the lender to repossess the car if the borrower falls behind on payments. Once the loan is fully paid off, the lien is released.

A car loan typically covers up to 80% of the on-road price of the car. The remaining 20% has to be borne by the borrower.

Unlike personal loans that can be used for any purpose, a car loan must be spent only to buy a car.

The Difference

It’s important to understand the difference between both the types of loans to reach an informed decision on which loan should be availed of.

Interest Rate:

The interest rate on a personal loan is generally much higher than that of a car loan due to higher risk involved in the absence of a collateral. The rate of interest on a car loan currently starts from 7.25% and goes on to as high as 14.00%. On the other hand, the rate of interest on personal loans starts from 11.00% and can go up to 34.00%.

Tenor:

A personal loan can be availed for a few months to as much as five years. A car loan is usually taken out for at least three years, going up to eight years.

Collateral:

This is the biggest difference between a personal loan and a car loan. Personal loan doesn’t require the borrower to provide any collateral such as property or gold to the lender. In the case of a car loan, the car itself acts as the collateral.

Amount:

There might be a situation when the borrower may not have the funds to pay the 20% of the on-road price of the car. In these cases, opting for a personal loan might be a good option as the borrower will be able to get the entire amount at once.

Ownership:

A big difference between the car loan and the personal loan is the ownership of the vehicle. Since car loans are secured loans, the ownership of the vehicle will be transferred to the borrower only after they have repaid the entire loan amount. On the other hand, a personal loan will provide the ownership immediately as soon as the borrower purchases the car.

Approval Process:

Getting an approval for a personal loan can prove to be a more difficult procedure compared with a car loan because of the absence of a collateral. A borrower with a poor credit score may face rejection of the personal loan application, but may secure a car loan because of the presence of a collateral.

Tax Benefits On Car Loans For Electric Vehicles

Under Section 80EEB of the Income Tax Act, a borrower can get a tax rebate of Rs 1.5 lakh on the interest paid for a car loan availed for an electric vehicle. The deduction is available for both personal and business purposes.

However, the tax deduction is available only for those electric vehicle loans sanctioned between April 1, 2019, and March 31, 2023.

Conclusion

There cannot be a one-size-fits-all approach to the question of which loan to be availed of for buying a new car. The borrower needs to weigh the pros and cons of both the loans carefully.

The total amount of interest a borrower pays on the personal loan or the car loan is determined mainly by his credit rating and credit score. In general, a car loan will carry a lower interest rate than a personal loan. However, borrowers can take a personal loan if they have a good credit score.

At IIFL Finance, the interest rates on personal loans start from as low as 11.75%. Also, the loans do not have hidden charges, and come with easy repayment options.