The main difference between a car loan and a line of credit is that a car loan is an installment loan with a set monthly payment and a set term, for example 84 months, while a line of credit is an open-ended loan, generally with interest only payments.
Two common ways to finance a vehicle purchase are a car loan and a personal line of credit.
Both methods can get the job done, but one might be preferable over the other based on your personal and financial circumstances.
Here’s a quick overview of a car loan vs line of credit:
| Car Loan | Personal Line of Credit | |
|---|---|---|
| Type of Product | Installment loan | Revolving loan |
| Term Length | 5 – 7 years | Open Ended |
| Interest Rate | 1% – 8% | 3 – 10% |
| Secured / Unsecured | Secured | Secured and unsecured |
| Rate Type | Fixed or Variable rate | Variable rate |
Car Loan to Finance a New Vehicle
A car loan is a type of installment loan specifically tailored to finance a vehicle purchase.
To acquire a car loan, you’ll need to satisfy lenders’ eligibility criteria.
When assessing your application, lenders will consider various factors, including your credit score, income, and current debt load.
Car loans are secured credit products backed by the vehicle you purchase using the borrowed funds.
Most car loans come with fixed interest rates, which means your rate will never change throughout the loan term.
Variable-rate car loans are available, as well, which typically have lower starting rates.
Your finances play a central role in determining the rate lenders assign to you.
If you possess a low credit score and don’t have a reliable income source, you’ll likely fail to qualify for the best rates.
A car loan’s term usually spans five to seven years, though some lenders offer periods shorter and longer than this.
If you opt for a shorter term, you can expect a higher monthly payment and conversely, loans with longer terms have lower monthly payments.
Key insight
According to Statistics Canada, the average car loan interest rate in August 2021 was 4.79%.
Pros
1. Low interest rates
Compared to other types of credit products, lenders usually assign lower rates on car loans.
With an actual vehicle acting
as security for the loan, they face less risk, so they’re more inclined to offer lower rates to borrowers.
You’ll often see special pricing of 0% / 0.99% / 1.99% types of interest rates.
2. Fixed interest rate
Most car loans offer a fixed rate, which means you never have to agonize over the possibility of rising rates hiking your interest charges.
3. Fixed payment schedule
Car loans are a type of installment loan, which means your monthly or bi-weekly payment remains the same over your term.
This consistency and predictability will allow you to budget for your household expenses prudently.
Cons
1. Your car is collateral
Suppose you fall behind on your payments or default outright.
In that case, your lender can legally seize and sell your car to settle the outstanding debt.
2. Large monthly payments
Compared to a lease, financing a car means you are paying for the entire cost of the car over a number of years, which can translate to large bi-weekly or monthly payments.
These payments may put a strain on your finances, as they absorb a sizable chunk of your disposable income.
Using a Personal Line of Credit to Buy a Car
A line of credit is a revolving credit product that enables you to borrow as much money as you need anytime and up to a predetermined limit.
Lenders will evaluate your credit report, income sources, and assets, to determine what rate and credit limit to assign to you.
Generally, a line of credit is an unsecured loan product, meaning there’s no asset acting as collateral.
Unlike installment loans, which usually offer a fixed interest rate, personal lines of credit come with variable rates.
This means that the rate you pay might change over time based on interest rate movements in the broader economy.
Pros
1. Flexibility
You can borrow as much as you like up to your credit limit and have the option to structure your payment schedule as you deem fit.
You can make a prepayment against your principal balance anytime or stick to making interest-only payments (if your contract allows you to).
2. No collateral required
Most personal lines of credit are unsecured, which means there’s no requirement for you to pledge a personal asset as collateral.
Cons
1. High interest rates
With no asset backing the loan, lenders will charge you a higher rate to compensate for the additional risk they face by extending credit to you.
2. Possible increase in interest charges
You’re vulnerable to rising interest rates when you borrow through a line of credit, especially if you’re already struggling with a tight budget and have little wiggle room.
3. No fixed payment schedule
The lack of a predetermined payment schedule could incentivize you to contribute only the minimum payment required and you may have trouble paying off your principal.
The choice between a car loan vs line of credit for your next vehicle purchase can also be influenced based on how you earn income, on regular basis or in lump sums from project work.
Did you know?
Your bank can demand full payment of your line of credit balance at their discretion, even without cause. They possess this right due to a clause in the contract known as the “Right to Offset.”
