Is a Car Loan a Secured Loan?

When it comes time to buy a new or used car, figuring out how you will finance the purchase is an important decision. One of the key factors to consider is whether you want to take out a secured or unsecured loan. This will impact the interest rate, loan terms, and consequences if you miss payments. So is a car loan a secured loan?

The short answer is yes – in most cases, auto loans are secured by the vehicle you are purchasing. This means the lender can repossess your car if you default on the loan. However, there are some exceptions, so let’s take a deeper look at secured vs. unsecured loans and how they apply to financing a car.

What is a Secured Loan?

A secured loan requires an asset as collateral that the lender can seize if you fail to repay the debt Common examples include

• Mortgages – Secured by the home
• Car loans – Secured by the vehicle
• Home equity loans – Secured by your home equity
• Cash-out refinance – Secured by your home
• CD-secured loans – Secured by a certificate of deposit
• Securities-backed loans – Secured by investments

The asset acts as insurance for the lender. If you stop making payments, they can take possession of the collateral to recoup their losses. This makes secured lending less risky, so lenders often offer lower interest rates and more flexible terms compared to unsecured loans.

The downside is that defaulting on a secured loan could mean losing a valuable asset like your home or car. You need to be confident you can make the payments to avoid this worst-case scenario.

What is an Unsecured Loan?

With an unsecured loan, you do not put up any collateral. Common unsecured loans include:

• Credit cards
• Personal loans
• Student loans
• Payday loans
• Medical bills
• Personal lines of credit

Since there is no asset backing the debt, the lender takes on more risk when approving unsecured loans As a result, interest rates tend to be higher and loan amounts lower compared to secured debt.

However, the advantage is that if you run into financial trouble, the lender cannot seize your property. Defaulting on an unsecured loan damages your credit but spares your assets.

Are Car Loans Secured or Unsecured?

The vast majority of auto loans are secured debt, meaning your new vehicle serves as collateral. This gives lenders confidence to provide affordable interest rates and long repayment terms up to 72 or 84 months.

If you default on a car loan, the lender can repossess your vehicle and sell it to recoup their money. They must follow state laws regarding notifications and the right to cure the default before repossession. However missing payments gives them the legal right to take the car back.

While rare, it is possible to get an unsecured loan to purchase a vehicle. This is essentially a personal loan that you could use for any purpose, like financing a used car from a private party or paying cash for a new car.

Unsecured auto loans typically have shorter terms of 2-5 years and higher interest rates of 6-36%. The benefit is the lender cannot seize your car if you default. But this higher cost of borrowing may outweigh the reduced risk for most buyers.

Secured Car Loan Benefits

Here are some key benefits of choosing a secured auto loan:

• Lower Interest Rates – Expect rates as low as 2-6% for excellent credit from banks and credit unions.
• Longer Terms – Repayment terms up to 6 or 7 years help lower monthly payments.
• Larger Loan Amounts – Can borrow up to 100% of the car’s value.
• Build Credit – On-time payments are reported to credit bureaus.

Secured financing makes cars more affordable for the average buyer. Even those with past credit challenges can likely qualify for a reasonable interest rate on a secured auto loan.

Unsecured Car Loan Benefits

The potential benefits of an unsecured car loan include:

• Avoid Repossession – Defaulting damages credit but won’t cost you the vehicle.
• Flexibility – Funds are not tied to a specific car purchase.
• Faster Funding – Approval is faster since no collateral needs evaluation.

However, the much higher cost and accelerated repayment timeline make this option impractical for most buyers. The limited scenarios where it could make sense include:

• Buying from a private party with cash
• Gap financing for a down payment
• Allowing a family member to use the vehicle
• Protecting a classic or custom car from repossession

Secured vs. Unsecured Car Loans

Here is a quick comparison of the key differences between secured and unsecured auto financing options:

For most buyers, the lower cost and flexible terms of secured lending make it the obvious choice. But everyone’s situation is unique. Being aware of both options allows you to make the best decision for your needs.

What Credit Score is Needed?

The credit score needed to qualify for a secured car loan is generally in the fair to good range. Here are some guidelines:

• Excellent Credit (720+ score) – Qualify for lowest rates from 2-4% APR.
• Good Credit (680-719 score) – Expect approval with rates from 4-6% APR.
• Fair Credit (640-679 score) – May get approved with rates from 8-12% APR.
• Poor Credit (below 640 score) – Try applying at buy here pay here dealers or credit unions with subprime lending programs. Rates often 15% and up.

Having an established credit history with some installment loan experience (like student loans or credit cards paid on time) helps compensate for a less than perfect score.

Since unsecured loans depend solely on your creditworthiness, you typically need a score over 680 and significant income for the best chances of approval. But lenders have more flexibility with unsecured loans, so it’s possible to get approved with a lower score if you meet other requirements.

Tips for Getting the Best Car Loan Rates

Follow these tips to get the lowest interest rate possible on a secured auto loan:

• Check your credit reports – Make sure there are no errors or outdated negatives dragging down your scores.

• Pay down credit card balances – Lower balances relative to limits help your credit utilization ratio.

• Avoid new credit applications – Too many hard inquiries in a short period can raise flags with lenders.

• Shop within a 14-day window – Credit bureaus count multiple auto loan inquiries in a 2 week period as a single hard inquiry.

• Get pre-qualified – This shows you actual rate offers with a soft inquiry that does not affect your credit score.

• Make a sizable down payment – At least 20% down signals you are financially committed to the loan.

• Choose shorter loan terms – Opt for a 36 month term instead of 60 months to get the best rates. You can always pay more to pay off sooner.

Taking these steps allows you to show lenders you deserve the most competitive interest rates available. As an added bonus, managing your credit wisely helps you save money throughout your lifetime.

Alternatives to Traditional Car Loans

If you want to avoid a secured car loan, here are a few other options to consider:

• Borrow from 401(k) – Some plans allow you to borrow up to 50% of your vested balance for 5 years.

• Use home equity – A home equity loan or line of credit can provide funds at competitive rates.

• Ask for seller financing – Private party sellers may agree to their own financing terms.

• Lease the vehicle – Leasing does not involve actual financing of the car’s value.

• Buy with cash – If possible, avoid financing entirely by saving up or getting a personal loan.

Each alternative has its own pros and cons. Make sure you understand the details before choosing one of these options.

The Bottom Line

Secured auto loans are the most common and affordable way for the average person to finance a car purchase. This is reflected in lower interest rates, flexible terms, larger amounts, and built-in consumer protections.

Unsecured loans involve much higher costs and risks for most buyers. But they provide an alternative if you want to protect your vehicle from repossession or need flexible financing.

Understanding whether a car loan is secured or not helps set proper expectations. A secured loan means the car serves as collateral. An unsecured personal loan shifts all risk to the lender. Weighing the trade-offs allows you to confidently take the best path to finance your next set of wheels