Is a Car Loan a Secured Loan? How Auto Loans Work and What Happens if You Default

Most people need to finance at least a portion of their vehicle purchase. Auto loans make this possible by providing the lump sum needed to buy a car, which the borrower repays in monthly installments. But is a car loan considered a secured or unsecured type of debt?

The answer is that auto loans are secured debt because the vehicle serves as collateral for the loan This means the lender can repossess your car if you default on the loan. Understanding how secured auto loans work can help you make smart financing decisions when purchasing a vehicle

What Makes a Loan “Secured”

Secured loans require borrowers to pledge an asset as collateral for the debt. If the borrower stops making payments the lender can seize and sell the collateral to recover their losses. The most common types of collateral used for secured loans are

• Homes for mortgages
• Vehicles for auto loans
• Investment accounts for securities-based loans
• Valuable items for pawn loans

Requiring collateral gives lenders a back-up plan if borrowers default. This reduces their risk allowing them to offer lower interest rates and more flexible terms. The opposite of secured debt is unsecured loans, like credit cards or personal loans. These have no collateral so lenders charge higher rates to offset the additional risk.

How Auto Loans Became Secured Lending

In the early days of automobiles, cars were only for the very wealthy who could pay cash upfront. To expand the market, automakerspartnered with banks to create payment plans. General Motors established GMAC in 1919 to provide financing specifically for GM car buyers.

These early “auto loans” were installment sales contracts, with the car dealer retaining title until the loan was paid off. If the buyer defaulted, the dealer could easily repossess the car. This format allowed manageable monthly payments so more consumers could afford automobiles. But buyers had no recourse if the car was faulty.

Modern auto loans shifted the lending from dealers to banks and credit unions, while keeping vehicles as collateral. This gave buyers more consumer protections while providing affordable financing options. Requirements like down payments and income limits also help lenders control risk.

The Process of Getting an Auto Loan Today

The auto loan process still centers around the vehicle serving as collateral:

• You choose the car first – Look for vehicles in your budget and test drive top picks. The purchase price sets the maximum loan amount.

• Get pre-approved for financing – Applying with lenders before visiting dealerships lets you know your rate and loan amount options.

• The dealer coordinates loan funding – After negotiating the car price, the dealer runs your financial information and connects you with the lender.

• You review and sign the sales contract – This covers the loan terms like APR, payment amount, and repo rights if you default.

• The lender disburses the funds directly to the dealer – They receive the full sales price and handle transferring the title and registration to you.

• You take ownership of the collateral – When all contracts are signed, you get the keys and drive off the lot as the new legal owner.

• You repay the loan in monthly installments – Auto loans have set repayment terms, often between 3-6 years. The car belongs to the lender until you pay the loan off.

What Happens if You Default on an Auto Loan?

Making the monthly payments on time keeps your auto loan status in good standing. But several missed payments can put your loan into default status, giving the lender certain rights, like repossessing your car.

Here is the general repossession process if you default on an auto loan:

• The lender sends written notices after missed payments, asking you to bring the loan current.

• If you are unable to resume payments, the lender can declare the loan in default after 3-6 months of nonpayment in most states.

• The lender contacts you to voluntarily surrender the vehicle. If you don’t, they can use a locksmith or tow truck to repossess it from your home or in public.

• They will sell the car at auction and use the proceeds to cover the remaining loan balance plus fees.

• If the vehicle sale doesn’t cover the total amount owed, you are still responsible for repaying the deficiency balance.

• The repossession and auction process plays out very quickly, often within a month of the initial repo.

• Your credit reports will show the defaulted loan and repo, damaging your credit for several years.

Alternatives to Secured Auto Loans

Very few lenders offer unsecured loans specifically for car purchases. But some alternatives provide financing without your vehicle at stake:

• Unsecured personal loans – Funds are not restricted to an auto purchase, but can be used for a down payment or part of the overall cost. Rates are usually higher.

• Borrower pay plans – Some dealers offer their own internal financing for buyers who don’t qualify for traditional auto loans. This keeps the collateral risk with the dealer.

• Co-signed loans – Adding a co-signer with good credit reduces the lender’s risk, sometimes allowing approval without using the car as collateral.

• Cash purchases – Savers who can pay the full price in cash have no collateral risk and can own the car free and clear.

Is Secured Financing Your Best Auto Loan Option?

For most buyers requiring financing, secured installment loans remain the most common and affordable way to pay for a vehicle over time. But carefully consider the repo risks, and pursue alternatives if you are concerned about default. Be realistic about what monthly payment fits your budget to keep your new wheels securely in your garage.