What is a secured auto loan and How does it work?

A secured car loan uses the car you're buying as collateral. This is the standard option on the market. The majority of banks, credit unions, online lenders, and dealerships offer privately secured auto loans. This helps keep rates competitive and helps reduce lender risk, which helps people with poor credit or no credit history qualify.

Since the loan is secured by the car, you can get it back if you are unable to make the payments. However, a secured car loan is usually the best option for most borrowers. Along with more competitive rates, lenders can offer terms of up to 96 months and a relatively quick application process. So while an unsecured loan has its benefits, you may be better off finding and qualifying for a secured car loan.

What is a secured car loan and how does it work?

A secured car loan is the most common type of car loan. They are offered by a wide range of lenders who work with a variety of borrowers. While the requirements you need to meet vary by lender, finding and qualifying for a secured car loan is generally very easy.

As with any loan, you will be responsible for paying this amount plus interest and fees. When you take out a secured car loan, you use the car you're buying as collateral for the loan. This means that the lender will retain ownership of the vehicle until you have completed the loan payments.

If you are unable to pay, the lender can take back your car and sell it to make up for the loss. For this reason, lenders are more likely to offer competitive rates and work with borrowers with bad credit.

Advantages of secured auto loans

If you are looking for a lower interest rate or want to finance a more expensive car, a secured loan can be a good option. Since these are the standard option for buying a car, it will be easier to find a secured car loan than to get an unsecured car loan.

A large amount of debt

When you get a secured car loan, lenders will often finance 110 percent to 125 percent of the car's value. This allows you to purchase extras such as gap insurance or an extended warranty without spending money out of pocket. Although the amount you can borrow is limited based on factors such as your income and other debts, you can usually find a secured loan to cover the cost of more expensive vehicles.

Unsecured auto loans are simply personal loans used to purchase a vehicle. These loans are usually beyond $50,000. And some personal loans have much lower limits in the $25,000 to $35,000 range. This limits the total amount you can spend on the car.

With an average financing amount of $40,851 for new vehicles starting in 2023 and $26,420 for used vehicles, it can be difficult to find an unsecured loan that can cover the cost. While you may be able to cover a used car, covering the full cost of a new car—especially if you opt for the add-ons and advanced features—is too much for most borrowers, and it can be challenging.

Easy to Qualify

Another advantage of getting a secured loan is that it is easy to qualify for. In addition to your credit score, income, and debt-to-income ratio, the lender will also consider the price of the vehicle you want to buy. Since the car is collateral for the loan, you can qualify for a loan even without a high credit score. If you do not have great credit, a secured loan can be a good option because the lender does not take as much risk when they have collateral.

Since an unsecured loan has no collateral, the lender is entirely dependent on your credit score and income. This limits your borrowing power.

Low interest rate

Secured auto loans have lower rates than their unsecured counterparts. The average interest rate for a new secured car loan is 6.58%. For used car loans, it's 11.17%.

The average unsecured personal loan rate at the end of July 2023 is 11.27 percent. If you're looking for a used car, the difference doesn't matter much. But for new cars, you are more likely to get a competitive rate with a secured car loan.

Even lenders like Lightstream that offer unsecured auto loans don't offer the most competitive rates. Lightstream has an introductory annual percentage rate of 8.99 percent for well-qualified borrowers. Because secured auto loans have lower introductory rates, they can be a much better option when you're shopping around for your loan.

Possible downsides of secured auto loans

While secured car loans are a common option, they are not appropriate for every consumer.

Less flexibility. While secured auto loans allow you to roll over add-ons, they can only be used for vehicle-related expenses. An unsecured personal loan can be used for almost anything and can be used for multiple expenses at once.

Used vehicle restrictions. When you take out a secured car loan, many lenders set mileage and age limits on used cars. There is no possibility of imposing any restrictions on unsecured debts, including redemption or rebuilding of title.

Rollback is most likely. If you default on your secured auto loan, your lender can repossess your car. With unsecured debts, the creditor has to go to court to collect your debts.

If you specifically want to purchase an older used car, it may be best to use an unsecured loan instead.

Bottom Line

In the end, most of the borrowers go with a secured auto loan. While an unsecured loan may be beneficial in certain situations, choosing a secured car loan will likely be the best option. Take the time to compare different lenders to ensure that you walk away from the market with the best deal.