You might think of a car loan as one that uses the vehicle as collateral — in other words, a secured loan. Another option exists: an unsecured loan when the vehicle isn’t put up as collateral. This is a significantly different type of loan structure.
A car loan can either be secured with collateral or unsecured without collateral, and both options can provide you with financing to buy a car. So, what exactly are the differences between an auto loan that’s secured or unsecured, and which is better? Below, we highlight the pros and cons of a secured vs. unsecured auto loan to help you determine which one is right for you.
Key Points
• Typically, auto loans are secured by the vehicle being financed, meaning the lender can repossess the car if the borrower defaults on the loan.
• Some lenders offer unsecured auto loans, which don’t require collateral but often come with higher interest rates due to increased risk for the lender.
• Secured loans generally offer lower interest rates and longer repayment terms compared to unsecured loans, as the collateral reduces the lender’s risk.
• Since unsecured loans lack collateral, lenders place greater emphasis on the borrower’s credit history and income to assess repayment ability.
• If a borrower defaults on a secured auto loan, the lender has the right to repossess the vehicle to recover the outstanding debt.
What Is a Secured Auto Loan?
When wondering is auto loan secured or unsecured, there are basic differences to know. First, a secured auto loan is financing that helps a borrower buy a new or used car while giving the lender a security interest in the financed vehicle. Lenders may repossess the vehicle as collateral if the borrower fails to make required payments on the secured car loan.
The security interest is a lien that holds the vehicle as collateral until the car loan is paid off in full. Lenders — or the lienholder of your secured auto loan — may hold the car title until you pay off the debt.
What Is an Unsecured Auto Loan?
An unsecured auto loan is financing that helps you buy a car without giving the lender a security interest in the vehicle. Borrowers can use this type of loan — usually a personal loan — to buy a new or used car without pledging any assets as collateral.
Lenders may offer a higher annual percentage rate (APR) for unsecured car loans because the loan is not secured with collateral, which means the lender may not seize your car in the event of default.
Are Auto Loans Secured or Unsecured?
Most auto loans are secured by the financed vehicle, but lenders may also offer unsecured auto loans, though they are much less common.
As mentioned, with a secured auto loan, if you fail to make your payments, the lender has the right to repossess the car to recover their losses. This setup reduces the lender’s risk, which often results in lower interest rates compared to unsecured loans. Because the vehicle backs the loan, lenders are generally more willing to approve financing, even for borrowers with less-than-perfect credit.
Secured vs Unsecured Car Loans
When deciding between secured vs. unsecured loans, it’s important to consider the pros and cons of each:
| Pros | Cons | |
|---|---|---|
| Secured Auto Loans | Because there’s collateral involved, it may be easier to get loan approval due to reduced risk for the lender. | If you default on payments, you may lose the vehicle. |
| Because of the lender’s reduced risk, your interest rate will likely be lower than with an unsecured loan. | You’ll need to have your credit checked, and your score must meet lender guidelines. Late payments can negatively affect your score. | |
| Lower interest rates can mean lower monthly payments. | The value of the vehicle must be verified as high enough to support the loan amount. | |
| Unsecured Auto Loans | No vehicle assessment is needed and, if you default on payments, the car is not directly at risk. | If your credit score doesn’t meet the lender’s standards, the loan may get denied or you may receive a higher interest rate. |
| The loan helps you buy a new or used car without giving the lender a security interest in the vehicle. | Unsecured loans typically come with higher interest rates than secured loans. |
When deciding between secured vs. unsecured loans, it’s important to consider the pros and cons of each:Here are some of the factors that a lender may consider when deciding whether to approve or deny your secured or unsecured car loan application:
• Proof of identity
• Annual income
• Credit history
• Credit check results
• Debt-to-income ratio
Here’s a rundown on some of the car loan requirements:
Income
Lenders may check to make sure you have enough income to afford a car loan, and what “enough” means can vary by financial institution. Ways that lenders may verify your annual income include asking for pay stubs, bank statements, or tax returns.
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Credit History
Because past payment history can predict a person’s future actions, lenders may want to see that borrowers have a pattern of meeting their financial obligations. As such, a review of your credit history is typically part of the loan approval process for a vehicle.
Credit Check Results
Results of your credit check can play a key role in determining what interest rate you’re offered. Borrowers with excellent credit may qualify for a 0% APR car loan secured by the financed vehicle.
Debt-to-Income Ratio
Your debt-to-income ratio (DTI) calculates the percentage of your pretax income that goes toward your monthly debt payments. Lenders like to see low DTIs — generally below 36% — because a low DTI reduces their levels of risk, while a higher one can indicate that a borrower is carrying too much debt for their gross income.
How Can I Get an Unsecured Auto Loan?
Here are the steps you may take to get an unsecured car loan:
1. Shop Around for Unsecured Car Loans
With an unsecured loan, seek out lenders that will loan on a car without requiring collateral. Lenders may offer this type of financing as a signature loan or unsecured personal loan.
2. Fill Out and Submit Your Loan Application
You can fill out and submit your unsecured loan application with the lender of your choice. Good credit scores are especially important for unsecured loans because the lender generally makes approval decisions based on the applicant’s financial record and situation. The interest rate may also depend on the individual’s credit score.
3. Receive Your Loan
Loan approval is never guaranteed, but lenders may approve your unsecured car loan if you meet the lender’s underwriting standards. Just like with secured loans, a lender may want to assess whether you have enough income to make the payments. You may get approved for tens of thousands of dollars in financing if you have excellent credit and a DTI below 36%.
4. Find and Buy a Car
You can find and buy a car using an unsecured loan. The loan can help you buy a new or used car from a dealership or private seller.
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Car Financing Options
When shopping for an auto loan, it’s important to assess your options. You’ll want to set your budget before you head out shopping, and it’s also a good idea to check your credit in advance so you have a good sense of where you stand and what your odds of qualification are. This could give you a sense of whether you may need a cosigner.
You may shop for car loans from multiple sources. Getting prequalified or preapproved can help you compare rates. Once you have an auto loan offer in hand, it is critical to read the fine print before you commit. Specifically, keep an eye out for your interest rate, the length of a car loan, any fees and penalties, and other key aspects of the agreement before moving forward.
If you already have a car loan and are looking to reduce your monthly payments, consider auto refinancing. If you’ve got a more challenging situation, such as an upside-down auto loan where the loan amount is higher than the value of the car, it can take more research to find the right lender.
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The Takeaway
Auto loans can be divided into two broad types: secured, where the vehicle is put up as collateral, and unsecured, where a borrower’s credit history and financial situation are primarily considered when a lender makes an approval decision. Although the borrowing processes are similar in many ways, there are key differences between secured vs. unsecured auto loans.
If you want to change your current loan, an auto loan refinance may allow you to lower your interest rate, shorten or lengthen your term, or switch from an unsecured loan to a secured loan.
If you’re seeking auto loan refinancing, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your car in minutes.
FAQ
What is a secured car loan?
A secured car loan is a type of financing that helps a borrower buy a new or used car while giving the lender a security interest in the financed vehicle. The security interest is a lien that holds the vehicle as collateral until the car loan is paid off in full. Lenders or the lienholder of your secured auto loan may hold the car title until you pay off the debt. Lenders may seize the vehicle as collateral if the borrower defaults on the secured car loan.
What is an unsecured car loan?
An unsecured car loan is financing that helps you buy a car without giving the lender a security interest in the vehicle. Borrowers can use this type of loan to buy a new or used car without pledging any assets as collateral. Lenders may not seize your vehicle if you default on an unsecured car loan.
Are secured car loans better than unsecured car loans?
Your personal preferences may dictate whether a secured car loan or unsecured car loan is right for you. You may qualify for a lower interest rate on a secured car loan, but the lender may repossess your vehicle if you default. An unsecured car loan gives the lender no right to repossess the vehicle if the borrower defaults on the loan.
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