Is a Car Loan Unsecured or Secured? Understanding the Difference

Purchasing a new or used car is an exciting experience. However, most people need to finance their vehicle purchase through an auto loan. When applying for a car loan, you’ll encounter two main types: secured and unsecured. Knowing the difference between secured vs. unsecured car loans can help you make the best financing decision.

What is a Secured Car Loan?

A secured car loan uses the vehicle itself as collateral for the loan This means the lender can repossess your car if you default on the loan by missing payments

Secured auto loans are the most common type of car loan. Over 90% of car loans are secured debt. With a secured car loan, the lender registers a lien on the title. This gives them the legal right to take possession of the car if you fall behind on payments.

Lenders prefer secured loans because the collateral reduces their risk. If you stop making payments, they can seize and sell the car to recoup their losses. This lower risk allows lenders to offer better interest rates, usually between 3-7% for new cars and 4-8% for used.

Benefits of Secured Car Loans

Secured loans have several advantages:

• Lower interest rates – Secured loans almost always have lower rates due to less risk for the lender This saves you money over the life of the loan

• Longer terms – Secured auto loans can be repaid over longer periods, typically 24 to 84 months. This lowers the monthly payment

• Larger loan amounts – Secured loans provide financing for the entire purchase price, allowing you to buy a more expensive vehicle.

• Easier to qualify – The collateral makes lenders more willing to approve buyers with lower credit scores or income.

As long as you make the payments, a secured loan allows you to purchase the car you want while paying less interest over time.

What is an Unsecured Car Loan?

An unsecured car loan is issued without collateral. The lender provides financing without a lien on the vehicle. If you stop making payments, they cannot repossess your car.

Unsecured loans are less common for auto financing. This is because the lender takes on more risk without the ability to seize the car.

Unsecured car loans typically fall into two categories:

• Personal Loans – These unsecured loans can be used for any purpose. You receive the funds upfront in a lump sum to purchase a vehicle from a private seller.

• Dealer Financing – Some dealers will provide unsecured financing on older, low-value vehicles they want to move off the lot.

In both cases, the lender has no recourse other than damaging your credit if you default.

Drawbacks of Unsecured Car Loans

While unsecured loans provide more flexibility, they come with some caveats:

• Higher interest rates – Unsecured loans almost always have higher interest, from 5-20% or more, because of the increased risk to the lender. This results in paying more over the loan term.

• Shorter terms – Unsecured loans typically have much shorter repayment terms of 12 to 36 months. This increases the monthly payment amount.

• Lower loan amounts – Lenders limit financing to smaller dollar amounts given the lack of collateral. Buying a higher-priced car may require a down payment.

• More difficult to qualify – Borrowers need higher credit scores and income to qualify for unsecured financing. Lenders want assurance you can repay without collateral.

For most buyers, the additional costs and limitations don’t outweigh the flexibility benefits of an unsecured car loan.

How to Get an Unsecured Car Loan

While less common, here are some tips for obtaining unsecured auto financing:

• Shop for a personal loan from an online lender like LendingClub or Lightstream. Avoid payday loans which have exorbitant rates.

• Ask the dealer about unsecured financing on older used cars. This may be an option on vehicles valued under $10,000.

• Consider a loan from your bank or credit union. Established relationships can provide access to unsecured loans.

• Improve your credit score above 700 and verify your income to show lenders you qualify.

• Apply with a cosigner who also has good credit history and income. Their guarantee lowers the risk.

• Be prepared for higher rates and fees. Compare loan costs including interest and origination fees.

Secured vs. Unsecured Car Loans: Which is Better?

For most car buyers, a secured loan has clear advantages thanks to lower rates, more flexible terms, and the ability to borrow larger amounts. But in some cases, an unsecured personal loan may provide the flexibility you need to purchase from a private seller.

Here are a few questions to help decide:

• How much do you need to borrow? Secured loans finance full amounts, including tax and fees.

• What is your credit score? Under 700 will be challenging for unsecured loans.

• What down payment can you make? At least 20% is recommended for unsecured financing.

• How urgent is your purchase? Unsecured loans have slower application and funding.

• How long is your ideal repayment term? Unsecured loans max out at 3 years usually.

Analyze your specific situation. For most buyers, the lower cost and better terms of secured loans make them the obvious choice. But unsecured loans still fill an important niche for certain situations. Understanding the difference allows you to pick the best loan for your needs.

Frequently Asked Questions

Can you get a car loan without collateral?

Yes, it is possible to get an unsecured car loan without providing the vehicle as collateral. However, unsecured auto loans are much less common and come with higher rates and more qualification challenges.

What happens if you default on an unsecured car loan?

With an unsecured loan, the lender cannot repossess your car if you default. However, they can damage your credit, assign the debt to collections, garnish your wages, or take other legal action to recover what is owed.

What credit score is needed for an unsecured auto loan?

Most lenders want to see a minimum credit score around 700 for an unsecured car loan, although requirements vary. Excellent credit and income are needed to qualify without collateral.

Can you get a personal loan to buy a car?

Yes, personal loans can provide unsecured financing to purchase a vehicle. However, interest rates are usually much higher, and the loan amount may not cover the full cost.

Is it hard to get approved for an unsecured auto loan?

Unsecured loans are more challenging to obtain given the higher risk for lenders. Expect a hard credit pull, proof of income, and potentially a substantial down payment requirement.

The Bottom Line

When financing a car purchase, secured loans are the most affordable option for most buyers. The vehicle serves as collateral, allowing lenders to offer lower interest rates and more flexible terms.

Unsecured loans are riskier for lenders, so they come with higher rates and stricter requirements. But they provide an alternative if you need flexibility to buy from a private seller.

Understanding the trade-offs allows you to make an informed financing decision. Analyze your budget, credit profile, and needs to determine if a secured or unsecured car loan is the right choice.