Ever wondered why car loans tend to be cheaper than personal loans? The answer lies in ‘security’. Chris Walker reports.
March 10, 2010
Car loans work in much the same way as personal loans. You borrow a set amount, with the rate and repayments fixed over the loan term. However there can be substantial differences in the interest rate charged on a car loan compared to a personal loan.
A quick look at the loans available through RateCity confirms that the rate applicable to many car loans can be less than 9% compared to about 13% for some of the cheapest personal loans. The difference of around 4% is substantial, and the reason for the saving is because car loans are typically ‘secured’ whereas personal loans are ‘unsecured’.
The distinction between the two is important, and not just because of the rate you’ll pay. A secured car loan is one where the lender holds security over a particular asset – in this case your car, until you have paid off the loan.
If you default on the loan, meaning you stop making repayments, the lender of a secured loan has the right to take possession of the secured asset and sell it to recover the outstanding loan balance.
It’s a good reason to be sure you can comfortably manage the loan repayments before committing to the debt. Falling behind with the loan could mean losing your vehicle altogether.
The issue of security also explains why lenders often impose varying conditions on their car loans. Car loans may only be available for younger vehicles, often less than two years old. Alternately lenders may impose a minimum loan balance, in some cases $30,000, which rules out using this type of finance for a road-weary alopy.
If you fail to meet the criteria for a car loan, a personal loan is a good substitute. But don’t be fooled by the description of the loan as ‘unsecured’. If you default on an unsecured loan, the lender can still take action to recover the debt. This includes placing the debt in the hands of a debt recovery agency, which could result in a court order demanding that you provide sufficient assets to pay off the remaining principal.
The bottom line is to be sure you can pay off a vehicle. A dedicated car loan will be cheaper but if you’re buying a budget vehicle or an older model, chances are a personal loan is your more likely option. Either way, if you skip the repayments, the lender can take action to reclaim their money.