Is a Car Loan a Secured or Unsecured Loan?

Buying a new car is an exciting experience However, it also involves a large financial commitment in the form of a car loan. When applying for an auto loan, you’ll have to decide whether you want to go with a secured or unsecured loan. But what exactly is the difference, and how do you know which one is the better choice for your situation?

In this comprehensive guide, we’ll explain the key differences between secured and unsecured car loans, the pros and cons of each, and help you determine which type of auto loan is the right fit for your needs.

What is a Secured Car Loan?

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

The most common types of secured auto loans are

• Loans from banks or credit unions
• Loans financed directly through the car dealership
• Leases

Secured car loans make up the vast majority of auto financing. Over 90% of car buyers use some form of secured auto loan to pay for their vehicle.

What is an Unsecured Car Loan?

An unsecured car loan does not use the vehicle as collateral. Instead, approval is based solely on your creditworthiness.

Unsecured loans are riskier for lenders because they have no way to recoup losses if you can’t repay the debt. As a result, unsecured car loans are extremely rare. Less than 1% of car buyers use an unsecured loan to finance their purchase.

The most common type of unsecured auto loan is a personal loan from an online lender or credit union. While you can use the funds from a personal loan to buy a car, the lender cannot repossess your vehicle if you default since it is not tied to the loan.

Is a Car Loan Secured or Unsecured?

The simple answer is that the vast majority of car loans are secured debt.

There are a few key reasons why secured loans dominate the auto financing industry:

• Lower Interest Rates – Secured loans offer lower interest rates, often 3-5% lower than unsecured loans. This saves you thousands of dollars in interest over the loan term.

• Higher Approval Odds – Lenders view secured loans as less risky so it’s easier to qualify, even with bad credit. Those with poor credit have little chance of getting an unsecured car loan.

• Larger Loan Amounts – You can borrow more money with a secured auto loan, often 100% or more of the car’s value. Unsecured personal loans have lower limits.

• Longer Terms – Secured car loans can be repaid over 6-8 years. Unsecured loans max out at 5 years. The longer term lowers the monthly payment.

While unsecured loans provide more flexibility and less risk, the clear benefits of secured auto loans for both lenders and borrowers make them the go-to choice for financing a car purchase.

Pros of a Secured Car Loan

Let’s take a more detailed look at some of the biggest advantages offered by secured auto loans:

Lower Interest Rates

Secured car loans come with significantly lower interest rates than unsecured loans. This is because the collateral (your car) reduces the lender’s risk. If you default, they can take back the vehicle and sell it to recoup their losses. Rates for a secured auto loan can be as low as 2-5% for those with excellent credit.

Easier to Qualify For

Lenders have more stringent approval requirements for unsecured loans because of the increased risk. But with a secured car loan, even those with fair credit in the 580-669 range can often qualify for financing. The ability to repossess the car allows lenders to take a chance on borrowers with less than perfect credit.

Borrow More Money

Secured loans provide the ability to finance up to 100% or even more of the car’s value. This allows you to purchase the vehicle you want while minimizing the down payment needed. Unsecured personal loans max out at around $40,000 so they aren’t practical for financing an expensive car.

Longer Loan Terms

Most secured auto loans can be repaid over terms of 6-8 years. This longer timeframe lowers the monthly payment and makes expensive vehicles more affordable. Unsecured loans typically max out at 3-5 year terms, resulting in higher monthly payments.

Cons of a Secured Car Loan

While they offer multiple benefits, secured auto loans also come with a few potential downsides to consider:

Your Car Can Be Repossessed

The biggest risk is having your vehicle repossessed if you fall behind on payments. Once you default, the lender can seize the car, sell it, and keep the proceeds. This can severely damage your credit score and finances.

Require Comprehensive Coverage

Most lenders require you to carry full coverage insurance that includes collision and comprehensive. This increases insurance costs compared to just liability coverage.

Prepayment Penalties

Some secured car loans include prepayment penalties that kick in if you pay off the loan early. This makes it expensive to refinance or trade-in the vehicle before the loan term ends.

Higher Long-Term Costs

While monthly payments are lower, longer 6-8 year loan terms mean you pay more interest over the life of the loan. Shorter 3-5 year unsecured loans cost less overall.

Pros of an Unsecured Car Loan

Unsecured personal loans used to purchase a vehicle also come with their own set of advantages:

Less Risk of Losing Your Car

With an unsecured loan, the lender cannot repossess your car since it is not tied to the debt. This reduces stress and financial risk if you run into issues making payments.

Insurance Flexibility

You aren’t required to carry comprehensive and collision coverage on an unsecured loan. Liability insurance is sufficient, reducing your total auto insurance costs.

No Prepayment Penalties

Unsecured loans don’t impose prepayment penalties for paying off your debt early. This makes it easier to refinance or trade-in your vehicle when you want.

Lower Long-Term Costs

While the monthly payment is higher, the shorter 3-5 year loan terms mean you pay less interest over the full repayment period compared to a 6-8 year secured loan.

Cons of an Unsecured Car Loan

Unsecured loans also have a few potential disadvantages, including:

Higher Interest Rates

Interest rates for unsecured loans are typically 8-10% or higher for those with good credit, 3-5% above secured auto loan rates. This difference really adds up over the loan repayment period.

Harder to Qualify For

Since unsecured loans are riskier for lenders, approval standards are more stringent. You generally need good-excellent credit to qualify for a decent rate and amount.

Lower Borrowing Limits

Personal loans max out around $40,000, sometimes lower. This makes unsecured financing impractical for purchasing more expensive cars and trucks.

Shorter Terms

Unsecured loan terms top out at around 5 years. The shorter timeframe leads to much higher monthly payments compared to the longer terms available for secured loans.

Should You Get a Secured or Unsecured Car Loan?

So when it comes time to finance your next vehicle purchase, should you opt for a secured or unsecured auto loan?

For most buyers, a secured car loan offers clear advantages that make it the best choice:

• Lower interest rates save thousands over the loan term
• Easier approval helps those with less-than-perfect credit
• Larger loan amounts enable financing expensive vehicles
• Longer terms of 6-8 years reduce the monthly payment

Unsecured loans really only make sense for those with excellent credit who need shorter terms to get the lowest overall interest cost. For the vast majority of car shoppers, a secured auto loan provides the best combination of low rates, high borrowing power, and manageable monthly payments.

Just be sure to only borrow what you can comfortably afford to repay each month to avoid any risk of repossession down the road. With responsible use, a secured car loan can help you get in the driver’s seat of the vehicle you’ve always wanted while fitting within your budget.

Key Takeaways:

• A secured car loan uses the vehicle as collateral while an unsecured loan does not.
• Over 90% of auto loans are secured debt because it offers clear benefits to both lenders and borrowers.
• Secured loans have lower interest rates, higher approval odds, larger amounts, and longer terms.
• Unsecured loans provide more flexibility and lower long-term costs but are hard to qualify for.
• For most buyers, a secured loan is the best option for financing a car purchase.