Is a Car Loan Secured or Unsecured?

How Does a Secured Car Loan Work?

An auto loan you get from a car dealer, auto finance company, bank, credit union or online lender will be a secured loan that uses the car as collateral. All types of secured loans are backed by an asset. For example, if you use a mortgage to finance a home purchase, your house secures the loan. That means the lender is within their rights to repossess that asset if you fail to make good on your loan payments—and that could severely damage your credit.

Most secured car loans also require a down payment. The minimum amount varies from one lender to the next, but putting some cash down upfront will result in a smaller loan amount. That can reduce your borrowing costs and monthly payment. Like many other loans, secured car loans typically come with fixed monthly payments over a specified loan term.

Learn more: How Does Financing a Car Work?

Is a Secured Loan Right for You?

Secured auto loans are the primary way to finance a car, and they have several advantages. An auto loan might be a good option for you if:

• You're looking for a lower interest rate. Secured loans are less risky for lenders, so they often offer a range of interest rates. Many dealerships offer competitive financing offers that may include 0% APRs on select models. You can prequalify for several auto loans to see who offers you the lowest interest rate.
• You don't have great credit. Auto lenders may be more willing to work with you if the financed car is being used as collateral. Every lender has its own credit score requirements, but having steady income and a sufficient down payment could make up for lower credit scores.
• You want a longer loan term. Secured auto loans generally have repayment terms that can range anywhere from 24 to 96 months. A longer loan term could translate to lower monthly payments, but you'll spend more on interest in the long run.

How Does an Unsecured Car Loan Work?

Technically speaking, unsecured car loans don't exist. Instead, you can use a personal loan to buy a car. That means there's no collateral attached to the loan. As such, they typically come with higher interest rates, shorter terms and tighter eligibility requirements since they pose a greater risk to lenders. Every lender is different, but a poor credit score could make it difficult to borrow enough to cover the sale price.

While a personal loan lender cannot repossess your car if you stop making your payments, they can report missed payments and a default to the three main credit bureaus (Experian, TransUnion and Equifax). Each delinquency will stay on your credit report for seven years. The lender could also send your account to collections, garnish your wages or take legal action against you.

When Should You Consider Getting an Unsecured Loan?

Using an unsecured personal loan to purchase a car may not be a bad idea. It might be worth considering if any of the following scenarios apply to you:

• You don't want to use collateral. You might not like the idea of your lender having the power to repossess your car. Using an unsecured loan takes collateral out of the equation and allows you to purchase your vehicle outright.
• You want more flexibility. If you're making a large down payment, you might only need to finance a small amount of the purchase. Personal loans offer flexible loan amounts and can also streamline the car-buying experience. Once you have the funds, you can take your time, shop around and finalize the purchase from a dealership or private seller without having to bring an auto lender into the process.
• You don't want extra car insurance. If you have an auto loan or lease, the lender will likely require you to carry collision and comprehensive insurance. With an unsecured personal loan, you might simply buy enough car insurance to satisfy your state's minimum requirements. That said, going with less coverage could make paying for repairs difficult if your car is damaged in an accident or other incident.

Learn more: Personal Loan vs. Auto Loan: How Should You Finance a Car?

The Bottom Line

If you're in the market for a new car, know that you have options. Both secured and unsecured car loans can increase your purchasing power and get you into a new vehicle, but they work a little differently. The right one for you will depend on your financial situation and risk tolerance.

No matter what you choose, your credit score will likely be a key factor in your lender's decision. You can get your credit report and FICO^® Score^☉ for free from Experian.