A personal loan is a financial agreement (also known as a contract) in which one party – typically your bank – agrees to give you a specific amount of money which you can use to pay for the car. The full amount is required to be paid back in monthly instalments over a stipulated period of time.
These loans are generally not secured against the car you’re buying or any of your assets. As such, they are also known as unsecured or signature loans. Unsecured loans are usually advanced on the basis of your credit-history and ability to repay the loan from personal income.
The terms and conditions of a loan will vary from lender to lender, but will be specified in the contract. You must adhere to the repayment terms stated in the contract, especially repayment dates and interest rates.
The amount of personal loans ranges anywhere from $1,000 to $50,000 and depends on your credit rating. The better your credit score, the more money you can borrow for a personal loan. It is significant to note that some banks have a cap on how much you can borrow for a personal loan.
However, you may be able to take out a higher loan amount at a bank you already have a relationship with.
Taking a personal loan is recognized to be the most popular way to finance a car simply taking it out gives you instant ownership of the car. Furthermore, because you know your repayment amount is going to be the same every month, it makes it easier to budget. The interest rate you pay on a personal loan is also usually fixed (but not always).
Interest rates on personal loans are based on your credit history. The better your credit score, the lower your interest rate. Lower interest rates are ideal because it means you pay a lower cost for borrowing the loan. Some personal loans come with a variable interest rate that change periodically.
If you want to compare loans, you’d typically use the annual percentage rate (APR) to find out how much a loan will cost you over the repayment period chosen. If the APR isn’t mentioned then ask the question, the headline rate is not always what you get as it depends on your individual credit rating.
You typically have a set period of time to repay your personal loan. Loan periods are stated in months, e.g. 12, 24, 36, 48 and 60. It’s a temptation to take a longer repayment period which makes the monthly repayment smaller but the implications are the loan will be more expensive as you will pay more interest than if you had a shorter repayment period.
Your interest rate may also be tied to your repayment period. For example, you may have a lower interest rate with shorter repayment periods. This is why you’ll want to keep the loan period as short as possible.
The downside to a personal loan unsecured is that in the event of default any of your assets including your car could be seized. With dealer finance only the car is at risk in the event of payment default. The lender can also take additional collection actions which include reporting late payments to the credit bureaus, hiring a collection agency and filing a lawsuit.
A personal loan would be suitable if any of the following is true:
- You don’t have any deposit to put down on the vehicle.
- You want to own the car outright.
- You plan to keep the car for a while.
- You don’t want annual mileage restrictions.
You are able to make over-payments or pay off a personal loan in full before the end of your agreement without penalty. However if you repay more than a specific amount in any 12-month period the lender may charge compensation (although the amount the lender can charge is limited by law).