Secured vs. Unsecured Loans

Understanding Auto Loans

An auto loan is a loan received from a bank, credit union, or other lender for the express purpose of purchasing a vehicle. Loans are repaid over time, typically 24 to 84 months, and accrue interest, which you must repay along with the amount borrowed. Auto loans are usually for a longer period of time and a higher amount of money compared to other loans, like personal loans.

Auto loans are typically secured loans that use the vehicle as collateral. This means that if you default on the loan, the lender repossesses the car. Though unsecured auto loans could be available, they are usually only for people who have excellent credit, who aren't looking to spend as much, or borrow for as long.

If you're struggling with credit issues, an unsecured auto loan won't be available to you. Only those borrowers with the very best credit scores can consider a loan based solely on creditworthiness. Borrowers with less-than-stellar credit will likely have to finance through a subprime lender or special finance dealership, and will have to bring plenty of documentation to verify their situation.

Auto loans are considered by many people because of the specificity of the loan involved. They are specific to getting a car in that you can borrow a larger amount of money and repay it over a set period of time, specific to the loan term you're granted. Auto loans can't be used for other things, and can be easier to obtain than a large personal loan.

Secured Auto Loans

This is the most common type of auto loan out there, and they use the vehicle you purchase as collateral. If you stop making payments, the lender will send someone to take the car away from you. This is known as repossession, and it isn't the situation you want to find yourself in.

Secured auto loans are characterized by the fact that the vehicle is repossessed if you default on your loan. Like all loans, they come with a unique list of pros and cons.

Most times, when you need a loan to purchase a vehicle, you won't have a choice as to whether or not to select a secured or unsecured loan; auto loans are inherently secured. If you don't want to run the risk of repo, you might want to seek out an unsecured loan, but again, these are incredibly difficult to qualify for.

Unsecured Auto Loans

Unsecured auto loans, unlike other loans, don't use any collateral, and a recipient is granted the loan based on credit alone. This means you have to have tip-top credit scores and a flawless credit report. Unsecured auto loans are a type of personal loan, used for the purpose of getting a vehicle. Due to the fact that there is nothing to back it up, interest rates are typically very high, and loan terms are very short.

An unsecured auto loan isn't for everyone. In fact, they're designed for people with great credit, who don't need a traditional auto loan. Uses can include getting an older, high-mileage used car that can't be financed with a car loan, getting a classic car, or some other special situation.

Since these are personal loans, be prepared for a higher interest rate than on a car loan and a shorter time to repay it. But with credit in good enough shape to qualify for an unsecured loan, these shouldn't be an issue.

Key Differences Between Secured and Unsecured Auto Loans

The key difference between secured car loans and unsecured loans is that one is a loan for a vehicle that uses the car as collateral. The other is a personal loan with nothing to back it up if you default.

Comparing Costs and Risks

Rates and terms vary wildly for things like auto loans and unsecured loans. The rates and terms you're eligible for are dependent on your credit situation.

Both types of loans have their own unique risks involved. For example, you risk losing your car in a repo if you can't keep up with the payments. While losing the vehicle isn't a consequence of an unsecured loan, you run the risk of having other legal trouble, like being sued, if you default on the loan.

FAQs Section

What happens if I default on a secured auto loan?

If you default on a secured auto loan, the lender will hire a recovery company to come and repossess your vehicle. This can happen anywhere and anytime, and hiding your car from the repo man is against the law. The best thing to do before you default is to contact your lender and work something out. Believe it or not, they don't want you to default on your loan, and may have some options that can help.

Can I get an unsecured car loan with bad credit?

No. It's not likely that you can get an unsecured loan with bad credit. These loans are reserved for people with the highest credit scores and cleanest credit reports. Unsecured loans are given based on credit alone, and you must prove you're worth the risk to the lender, since there is no collateral to back up the loan.

How does interest differ between secured and unsecured loans?

Unsecured auto loans have even higher interest rates than secured loans, since there is nothing to back up the loan if you default. Since these loans are riskier, they carry a higher price to take one out. Since secured loans are also personal loans, they inherently have a higher interest rate than an auto loan. Additionally, automakers run special deals that can keep car loan interest rates lower for secured loans when you finance through their captive lenders.

Are there any hidden fees with unsecured auto loans?

Yes, there can be many hidden fees in an unsecured auto loan, so it's important to read the fine print carefully. Fees that could show up in an unsecured car loan include, but are not limited to: origination fees, pre-payment penalties, add-ons, late payment fees, payment returned fees, and payment processing fees. Some of these could be present in secured loans as well, and it's never a good idea to sign something before you read it.