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When it comes time to purchase a new or used car, one of the first things you’ll need to figure out is how you plan to pay for it. Most people can’t afford to pay cash outright for a vehicle, so they turn to auto financing options like car loans. But not all car loans are the same. One of the biggest differences is whether the loan is secured or unsecured.
What Does Secured vs. Unsecured Mean?
In simple terms, a secured loan is one that is backed by some kind of collateral that the lender can seize if you default on the loan. With a car loan, the vehicle itself serves as the collateral. So if you stop making your monthly payments, the lender can repossess your car and sell it to recoup their losses.
An unsecured loan, on the other hand, doesn’t require any collateral or security The lender is essentially taking your word that you’ll repay the debt as promised If you fail to make payments on an unsecured loan, the lender can’t lay claim to any of your assets. However, they can still damage your credit, sue you, or send the debt to collections.
Are Car Loans Secured or Unsecured?
The vast majority of car loans are secured loans. In fact, it’s pretty rare to find an unsecured car loan option. That’s because the car itself serves as a convenient form of collateral for lenders. They know that if the borrower stops making payments, they can repossess the vehicle and sell it to recoup at least part of the loan amount. This makes car loans less risky for lenders compared to unsecured loans.
Even if you have great credit most lenders will require your car loan to be secured by the vehicle. It’s simply the standard type of auto financing. Some lenders may offer unsecured car loans but it’s not common. You’ll also likely pay a much higher interest rate compared to a traditional secured car loan.
Why Are Car Loans Usually Secured?
There are a few key reasons why car loans are almost always secured loans rather than unsecured:
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Lower interest rates – Secured loans generally have lower interest rates because the collateral protects the lender in case of default. Rates for unsecured loans tend to be higher since they represent more risk.
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Bigger loan amounts – You can typically borrow more money for a car with a secured loan than an unsecured one. Again, the collateral makes lenders more comfortable providing larger loan sums.
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Longer terms – Car loans usually have terms of 36, 48, 60, or even 72 months. Long repayment periods are more common with secured loans and help keep monthly payments affordable.
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Easier to qualify – Even if you have less-than-perfect credit, lenders may be willing to approve a secured car loan. The collateral gives them confidence you can repay the debt. Unsecured loans typically require good credit.
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Tax benefits – With a secured car loan, you may be able to deduct the interest on your taxes if you itemize deductions. Interest paid on unsecured loans is generally not tax deductible.
So in nearly every case, a secured car loan ends up being the better option compared to an unsecured loan. That’s why it’s the standard type of auto financing used by most buyers.
Can You Get an Unsecured Car Loan?
While quite uncommon, it is possible to get an unsecured car loan from some lenders. This usually requires excellent credit – a FICO score of at least 720 or higher. Even then, you’ll likely pay a much higher interest rate with an unsecured car loan versus a traditional secured one.
Unsecured car loans also tend to have shorter repayment terms of 2-4 years. And there may be strict limits on how much you can borrow – often no more than $25,000.
Some other potential options for unsecured car financing include:
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Personal loans – You can apply for a personal loan from an online lender, credit union, or bank and use the funds to buy a car. Rates are generally higher than secured car loans though.
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Credit cards – If you have the available credit limit, you may be able to charge the entire purchase price of a car on a card. This is an extremely expensive way to finance a vehicle long-term however.
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Dealer financing – On very rare occasions, a dealership may offer unsecured financing to borrowers with pristine credit scores. But it’s not something you should count on being available.
As you can see, unsecured car loans are harder to come by and not necessarily an ideal financing option. But they do provide more flexibility since your vehicle isn’t on the line as collateral.
Secured Car Loan Requirements
If you want to go the traditional route and get a secured car loan, there are certain requirements you’ll generally need to meet:
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Down payment – Most lenders require a 10-20% down payment on a secured car loan. This provides an equity cushion and lower loan-to-value ratio. Buyers with poor credit may need to put down 25-30% or more.
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Co-signer – Applicants with limited credit histories or low credit scores are often asked to have a cosigner with good credit on the loan. This helps compensate for their higher risk profile.
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Proof of income – Lenders want to verify your income to ensure you can afford the monthly payments. Pay stubs or W-2s from your job will be requested. Self-employed borrowers may need to provide tax returns or profit/loss statements.
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Collateral – Obviously the car itself will be used as collateral on a secured auto loan. It must be titled in your name with no existing liens.
Provided you meet the lender’s requirements, getting approved for a secured car loan is a pretty straightforward process.
Unsecured Car Loan Requirements
Since unsecured car loans are riskier for lenders, qualifying standards tend to be more stringent. Typical requirements include:
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Excellent credit – A minimum credit score of 720 and consistent history of on-time payments is usually required for an unsecured auto loan. Anything less than great credit means almost certain denial.
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High income – Lenders generally want to see an annual income of at least $75,000-$100,000+ to qualify borrowers for unsecured car financing. A high income provides confidence in your ability to repay.
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Low debt-to-income ratio – Your total monthly debt payments, including the new car loan, would need to equate to no more than 15% of your gross monthly income, though 10% or less is ideal.
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Large down payment – Borrowers are expected to make a down payment of at least 30-50% on an unsecured car loan. This establishes immediate equity in the vehicle.
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Short term – Unsecured auto loans tend to have shorter repayment terms of 2-4 years since the risk is higher for lenders. A shorter term means your loan gets paid off quicker.
As you can see, the bar is set extremely high to qualify for an unsecured car loan. That’s why they’re so uncommon compared to secured auto financing.
Secured vs. Unsecured Car Loan: Pros and Cons
Here’s a quick rundown of the key benefits and potential drawbacks of secured and unsecured car loans:
Secured Car Loan
Pros:
- Lower interest rates
- Larger loan amounts
- Longer repayment terms
- Easier to qualify
Cons:
- Vehicle may be repossessed if you default
- Loan takes longer to pay off, meaning more interest paid over time
Unsecured Car Loan
Pros:
- Vehicle can’t be repossessed if you default
- Potentially faster loan payoff
Cons:
- Much higher interest rate
- Harder to qualify
- Smaller loan amounts
- Short repayment terms
For most buyers, the pros of going with a traditional secured car loan easily outweigh the benefits of an unsecured loan. But everyone’s situation is different, and your own financing needs and preferences should guide your decision.
Alternatives to Traditional Car Loans
Beyond secured and unsecured loans from banks and credit unions, there are a few other options for obtaining financing to buy a car:
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Dealer financing – Many dealerships have in-house financing departments that offer car loans directly to customers with little to no money down. Rates tend to be higher though.
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Manufacturer financing – Most major automakers offer special financing promotions through preferred lenders. These include deals like 0% APR for qualified buyers.
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Peer-to-peer lending – Online services like Upstart connect borrowers who need car loans with individual investors looking to earn interest on their capital.
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Lease – Leasing a car means you pay only for the vehicle’s depreciation during the lease term, not the entire purchase price. Down payments and monthly payments tend to be lower.
No matter what financing option you choose, be sure to shop around and compare multiple offers. This will help ensure you get the best possible deal on your new
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- Unsecured auto loans are personal loans you can use to buy a vehicle. They are not secured by collateral.
- You’ll generally need good or excellent credit to qualify for an unsecured auto loan.
- These loans pose an elevated risk to the lender and often come with higher interest rates and shorter loan terms.
- If you default on the loan, the lender could report the delinquency and sue you in court.
Traditionally, loans for big-ticket items — like homes and cars — use the item being purchased as collateral. If the consumer stops making payments, the lender can seize that collateral to cover the unpaid debt.
An unsecured auto loan — or a personal loan used to purchase a car — requires no collateral. Instead, if the borrower can’t pay, creditors can report the default to the credit bureaus and go to court to force collection since there is nothing to be repossessed.
Advantages and Disadvantages of a Secured Car Loan – Cost of Carry podcast Ep.76
FAQ
How do I know if my car loan is secured or unsecured?
Is an auto loan a secured or unsecured debt?
Is a auto loan a secured credit?
Is a car loan secured or not?
Are auto loans secured or unsecured?
Mortgages and auto loans are types of secured loans. Unsecured loans don’t require collateral but may charge a higher interest rate and have tighter credit requirements because of the added risk to the lender. Many personal loans and most credit cards are unsecured.
What is the difference between unsecured and unsecured car loans?
An unsecured loan, on the other hand, is not tied to any assets. If payments are missed, the lender has to pursue payment from the borrower through other legal means. That’s why unsecured loans typically come with higher fees and interest rates. Secured auto loans are the most common type of car loan for new and used vehicles.
Should you buy a used car with an unsecured loan?
If you want to buy a particularly old used car, it may be better to use an unsecured loan instead. Ultimately, most borrowers go with a secured auto loan. While an unsecured loan may be beneficial in certain scenarios, opting for a secured auto loan will likely be the best choice.
Do unsecured car loans have higher interest rates?
Unsecured loans typically come with higher interest rates than secured loans. Here are some of the factors that a lender may consider when deciding whether to approve or deny your secured or unsecured car loan application: