When it comes to auto loans, there are two different types: secured loans, and unsecured loans. While you may not hear the terms very often, most auto loans fall under the “secured” category. The difference lies in the car being collateral for the loan.
Table of Contents
What Is an Unsecured Auto Loan?
In an unsecured auto loan, there is no collateral that offers the lender security. An unsecured loan is more like a credit card in that you’re expected to pay, and if you don’t, the lender will go to a credit bureau or court to try forcing repayment.
Alternatively, a secured loan means that the car becomes collateral. If you stop making payments, then your lender can repossess the vehicle, protecting their investment.
How Does an Unsecured Auto Loan Work?
An unsecured loan is essentially a personal loan. Because the car isn’t being used as collateral, the lender doesn’t consider how the money is being spent, so long as the payments are made.
To get an unsecured loan, you’ll have to approach a bank or other lending institution and tell them the type of loan you’re looking for, and the amount you’re interested in. Once the paperwork has been completed, a formal review of your credit history will be done to verify your trustworthiness with the loan.
It’s likely that interest rates in these types of loans may be higher, and it might take longer to have the loan go through the approval process. If you’re approved, they will give you a check for the amount of money you requested, and then it is yours to spend on the vehicle of your choice.
Advantages of Unsecured Auto Loans
An unsecured auto loan allows you to become a cash buyer, and there are some benefits to approaching a car purchase from a cash perspective.
No Financing Through Dealership
When you have an unsecured loan, you’re not relying on the dealership for financing. That means you’ve made your purchase and you can walk away from them without another thought. You’re not tied into their rates and any other terms that their contracts contain.
Low Risk of Repossession
In almost every situation, an unsecured loan means there is a very low chance of repossession. Your lender has given you that money to do with what you wish, and your vehicle is not tied to your payments.
However, payments must still be made, and there are repercussions for defaulting, but your vehicle is not at the front line of that.
Loan Amount Not Limited to Car Value
When you apply for an unsecured loan, you select the amount of money you want to borrow. The loan amount is not determined by the vehicle you’re going to buy. That means you can ask for more and then you can go out and find a deal on the vehicle and use the extra for something else. You can also find a more expensive vehicle, use your money from the loan and pay the balance yourself.
Own The Car Outright
With an unsecured loan, you drive off the lot owning the vehicle. Of course, you still have a loan, but your vehicle ownership is not contingent on that.
Disadvantages of Unsecured Auto Loans
An unsecured loan sounds fantastic when you look at the advantages, but there are some disadvantages and they’re significant enough to make these loans fairly uncommon for auto purchases.
You Can Still Default
An unsecured loan is still a loan that you need to pay. Just because your vehicle isn’t on the line does not give you the option to default or quit payments. In fact, if you default on this loan, you’re responsible for paying the entire loan back, even if your lender has to take you to court.
If you default on a traditional car loan, the lender will take the vehicle away from you and you’ll lose everything you’ve paid toward the loan but, in most cases, that’s the end of it. The amount of money you’re out might be significantly lower than it would be if you defaulted on an unsecured loan but, of course, now you don’t have a car.
You Must Qualify
Qualifying for an unsecured loan is more difficult than qualifying for a secured loan because the lender is putting themselves at risk. This means that they’re going to take a hard look at your finances and your credit history. If you don’t have a stellar credit rating, a good job, and a low debt to asset ratio, there’s a big chance the lender will not give you the loan.
Even if you have the best credit possible, you’ll pay more for an unsecured loan than for a secured one. This is especially true when you consider that dealers often have 0% APR on new purchases for qualifying buyers. This just means you’ll be paying more in interest in the long-term for an unsecured loan.
Who Should Consider an Unsecured Auto Loan?
There are a few reasons you might want to pursue an unsecured auto loan. A big one is that it opens the door to a bigger variety of vehicle choices, from classic vehicles to used cars, the lender doesn’t care what you have when it’s an unsecured loan, whereas a secured loan lender will have restrictions on what vehicles they’ll finance. If getting your dream car is important to you, especially if that dream car isn’t brand new, then an unsecured loan is the way to go.
If having a vehicle is the most important thing to you then you’ll want to minimize the risk of losing that vehicle. For some, having a car is a prerequisite for their job, and losing their vehicle would mean the loss of their job and income. Having an unsecured loan protects your vehicle from repossession.
The flexibility of an unsecured loan can also be very appealing. Asking for a flat dollar amount lets you shop for a vehicle to find something that fits your budget. If there’s money left over, you can apply it to the loan or you can purchase something else.
Even if one or more of these situations applies to you, it’s still important to have a good credit score, a stable job or a high income, and a strong asset base to provide you with a good chance of qualifying for an unsecured auto loan at a fair rate.