What’s the difference between a personal loan and an auto loan?

Thinking about financing your next big purchase? Here's the lowdown on personal vs. auto loans: Personal loans offer flexibility – you can use them for almost any purpose. On the other hand, auto loans are specifically designed to help you buy a vehicle.

Because personal loans typically don't require collateral, they come with higher interest rates compared to auto loans, where your vehicle acts as security. Generally, personal loans are best for significant, one-off costs like consolidating debt or tackling home renovations. While you could use a personal loan to purchase a car, an auto loan will likely be the more budget-friendly option.

Auto loans vs personal loans

Is a personal loan or auto loan better?

Whether a personal or auto loan is the better choice will depend on your individual circumstances. Generally speaking, an auto loan will be a more advantageous option if you are looking to finance a vehicle. This is primarily because auto loans offer the lowest interest rates.

The reason auto loans tend to be cheaper boils down to security. Your car acts as collateral for the loan. If you fail to make payments, the lender has the right to repossess your vehicle to recover their losses. This lower risk for the lender translates to lower interest rates for you, a win-win for both.

Because the funds on a personal loan are unsecured, the sender offsets the risk with higher interest rates. Personal loans can be used for a variety of purposes, from weddings to home renovations. You may also choose to take out a personal loan on a vehicle under specific circumstances, such as when purchasing a used vehicle from a private seller. To get an idea of how much you could qualify for, you can make use of a personal loan calculator.

Reasons to go for a personal loan over an auto loan

While auto loans are often the go-to for financing a car, there are specific situations where a personal loan might be a more suitable choice:

• Private party purchases: While private-party auto loans exist, not all banks offer them, and their interest rates often tend to be higher than those for traditional auto loans from dealerships. A personal loan could simplify financing a car bought directly from a private seller, for instance, on Carousell. 

• Financing older vehicles: Securing an auto loan for a car that's over a certain age can be challenging, especially in Singapore where the loan term for older vehicles is determined by its date of registration. A personal loan might be a viable alternative in such cases.

• Avoiding collateral: With an auto loan, your car serves as collateral. This means the lender has a lien on your vehicle until the loan is fully repaid and can repossess it if you default. This could also complicate selling the car before the loan is paid off. If you would rather not use your car as security, even if it means accepting a higher interest rate, a personal loan might be preferable.

Despite these scenarios where a personal loan may be considered, the lower interest rates associated with auto loans generally make them the most financially sensible option for the majority of car buyers.

>> MORE: A comprehensive guide on unsecured personal loans

Rates and terms

We already know that auto loans typically offer lower interest rates than personal loans, but just how significant is the difference? The interest rate for auto loans does not usually exceed 3% and covers a much narrower range than that for personal loans, which can be a lot more variable. For instance, the POSB Personal Loan has an Effective Interest Rate (EIR) of 4.43% while the CIMB Personal Loan comes with an EIR of 5.06%.

When evaluating the viability of a loan, it’s important to consider the EIR on top of the nominal per annum (p.a.) rate, which can look attractive at first glance but does not tell the full story. EIR takes into account all the fees associated with your loan, including the p.a. rate and any administrative costs incurred. In simple terms, the EIR is the one you have to pay. 

Now that we have taken a closer look at the respective rates, let’s consider the loan terms. When financing a new car in Singapore, the maximum loan term is 7 years. The term for used cars will depend on its registration date. On the other hand, personal loans typically come with a term between 1 to 5 years. Keep in mind that there may be a penalty for early repayment with an auto loan as the lender is missing out on the interest you would have accumulated by sticking to the original loan term. 

>> MORE: How to calculate a car loan payment in Singapore

A step-by-step guide to applying for your auto or personal loan

Whether you have decided on an auto loan or personal loan, the application process will look similar. Follow these steps to get started:

1. Determine your eligibility: In most cases, applicants have to be above 21 years old with a minimum annual income of $20,000 to $30,000 (for locals).

2. Check your credit score: Understanding your credit score is crucial as it gives you a general idea of the interest rates you will qualify for. It's a good idea to review your credit score for any inaccuracies before applying for a loan. As this review would count as a soft credit pull, you don’t have to worry about it affecting your credit application. This check can be carried out via Credit Bureau Singapore (CBS).

3. Prepare documentation: Make sure you have your NRIC, proof of income, as well as bank statements ready to go.

4. Compare lenders and apply: It may be worth getting quotes from a few different lenders before deciding on the one that best matches your needs. Once you have decided on a lender, be sure to go through the contract carefully before signing.