Is My Auto Loan Secured or Unsecured? Understanding the Difference

When it comes time to finance a new or used car purchase, one of the first decisions you’ll need to make is whether to get a secured or unsecured auto loan This choice will impact the interest rate you pay, the amount of money you’ll borrow, and other key factors Below, we’ll explain exactly what secured and unsecured car loans are, the pros and cons of each, and how to decide which is best for your situation.

What is a Secured Auto Loan?

A secured car loan uses the vehicle you are purchasing as collateral for the loan. This means the lender can repossess your car if you default on the loan by missing payments. The lender’s ability to take the vehicle helps reduce their risk, allowing them to offer lower interest rates on secured auto loans.

Rates for secured car loans generally range from 3% to 20%, depending on your credit score and other factors like your debt-to-income ratio and down payment amount. The better your credit, the lower the rate you can qualify for.

Here are some key features of secured auto loans:

• Collateral: The car itself serves as collateral if you fail to repay the loan. This allows lenders to offer lower rates.

• Interest rates Usually range from 3% to 20% based on your creditworthiness, Prime borrowers with great credit can get rates under 5%

• Repossession Your lender can take back the car if you default on the loan, which includes missing payments

• Easier approval: Secured loans are easier to get approved for versus unsecured options.

• Loan amounts: Can borrow the full cost of the vehicle.

Secured car loans are issued by banks, credit unions, and other lenders. Most people use secured financing to pay for a new or used car from a dealership.

What is an Unsecured Auto Loan?

With an unsecured car loan, the vehicle itself does not act as collateral. This type of financing is riskier for lenders, so they charge higher interest rates to offset the chance of default.

Unsecured auto loans are often structured as personal loans that you can use for any purpose, including buying a car. Some key points about unsecured loans:

• No collateral: The car is not used as collateral if you default, but you can still face consequences like repossession.

• Higher rates: Interest rates usually range from 5% to 36% since these loans are riskier for lenders.

• Harder approval: You’ll need a good credit score and low debt-to-income ratio to qualify.

• Lower loan amounts: Lenders will only loan up to a certain percentage of the car’s value.

• Shorter terms: Unsecured loans come with shorter 2 to 5 year terms versus longer terms for secured financing.

While less common, unsecured loans can make sense in certain situations like if you have an old car that wouldn’t have much repossession value. They provide more flexibility but cost more in interest.

Secured vs. Unsecured Car Loan Comparison

Here is a quick comparison of the main differences between secured and unsecured auto loans:

As this table illustrates, secured loans offer distinct advantages thanks to the collateral, including better rates, more flexible loan terms, and the ability to finance the full car purchase price. However, unsecured loans provide more flexibility if you later have trouble making payments.

Pros and Cons of Secured Auto Loans

Pros

• Lower interest rates
• Easier approval
• Ability to borrow up to 100% of car value
• Long repayment terms up to 84 months

Cons

• Car can be repossessed if you default
• Require collateral (the car)
• Loan amounts limited by car value
• Must carry full coverage insurance

Pros and Cons of Unsecured Auto Loans

Pros

• Vehicle is not tied to the loan as collateral
• Can sometimes get loan without proof of income
• More flexible if you later struggle making payments

Cons

• Much higher interest rates
• Harder to qualify for
• Shorter repayment terms of 2 to 5 years
• Lenders won’t finance full car cost

Who Should Consider an Unsecured Car Loan?

Unsecured financing makes the most sense for certain borrowers:

• People with an old car not worth much as collateral
• Those who value flexibility in payments
• Drivers who can get a great rate on a personal loan
• Buyers with significant savings and assets
• People with great credit and a low debt-to-income ratio

You’ll need to have a strong credit score, low debt burden, and substantial savings to qualify for reasonable unsecured loan rates under 10% to 15%. If not, the high interest costs usually don’t justify choosing an unsecured loan.

Tips for Getting Approved for an Unsecured Auto Loan

Getting approved for an unsecured car loan can be challenging. Here are some tips to boost your chances:

• Have a credit score over 720 – This shows lenders you are very low risk. Some may require a score over 740.

• Lower your debt-to-income ratio – Unsecured lenders want to see you devote less than 36% of gross income to debt payments.

• Make a large down payment – Putting down 20% to 30% shows you are financially stable.

• Take a shorter loan term – Opt for a 3 year term instead of 5 years to look more attractive.

• Apply with an online lender – Many fintech lenders offer unsecured loans with automated decisions.

• Provide proof of income – While not always required, this helps get better unsecured loan rates.

By taking some or all of these steps, you can potentially get approved for an unsecured auto loan even if your credit score is marginal. Just be prepared for a higher interest rate.

Which Type of Car Loan is More Common?

The vast majority of auto loans are secured financing where the vehicle acts as collateral. This allows lenders to extend credit with less risk. Over 90% of car buyers use secured loans for their purchase.

Unsecured car loans are much less common, accounting for around 5% to 10% of lending. Most unsecured financing is in the form of credit cards or personal installment loans. Very few lenders will provide an unsecured loan specifically to purchase a car.

Secured auto loans dominate the market because they offer consumers better interest rates and repayment terms. The added flexibility and lower chance of repossession with unsecured loans usually isn’t enough to offset their higher costs for most buyers.

How to Get the Best Auto Loan Rates

Whether you go with a secured or unsecured car loan, here are some tips for getting the lowest interest rate:

• Shop around with multiple lenders to compare rates
• Consider credit unions, which often offer lower rates
• Look for promotional financing deals from auto manufacturers
• Improve your credit score and payment history
• Lower your debt-to-income ratio
• Make a larger down payment if possible
• Choose a shorter loan term so you pay less in interest

Taking these steps allows you to unlock the best auto financing rates, potentially saving you thousands over the life of your loan. The lower the rate, the less it will cost to finance your new car purchase.

Are Auto Loans Simple or Compound Interest?

The vast majority of both secured and unsecured car loans use simple interest rather than compound. With simple interest loans, you are only charged interest on the original principal balance. Your interest charges do not grow over time.

Meanwhile, compound interest means your unpaid interest gets added back to the principal loan balance. This results in your balance growing exponentially as interest builds on interest. Thankfully compound loans are very rare in auto financing.

Sticking with simple interest auto loans helps keep your total interest costs more affordable over the life of your loan. Make sure to verify the lender is using simple interest before signing your contract.

The Bottom Line

When financing a car purchase, going with a traditional secured auto loan offers big advantages thanks to the lower interest rates and flexible terms. Unsecured loans cost more and are harder to get, but provide more freedom down the road if you struggle to make payments. For most buyers, the best auto loan rates and terms will come with secured financing. But unsecured loans can fill niche needs too.

By understanding the core differences between secured vs. unsecured car loans, you can make an informed decision on the best loan type for your unique financial situation and needs. Be sure to compare multiple lenders and offers to find the ideal auto loan.