Secured & Unsecured Auto Loans: Understanding the Difference
A growing trend is that of purchasing vehicles with unsecured auto loans. Though, most of the time, people that finance a car purchase do so with secured car loans. While the trend is relatively new in the United States, purchasing a vehicle with an unsecured car loan has been popular in France, the United Kingdom and other countries in Europe for quite a number of years already. Having additional loan options is always a good thing, and unsecured loans give you another way to go when buying a vehicle. However, before you run out and apply for unsecured auto loan, you should be aware of the differences between traditional secured car loans and those of the newer unsecured variety.
The Basic Difference
The primary difference between a secured and unsecured car loan is collateral. Secured car loans are made with the vehicle that is purchased as collateral. The lender is listed as the lien holder, while you will be listed only as the registered owner and won't receive the car title until all payments are made. If you are unable to make the payments on your vehicle, the lender will simply ask you to return the vehicle, and if you are unwilling to return the vehicle - it will be repossessed.
Unsecured auto loans are usually actually personal loans or signature loans that are made based solely on your credit and your ability to repay the loan. There is no collateral required for the loan. So, when you purchase the vehicle, you are listed as the legal owner of the vehicle, are given the car title and there is no lien holder. With these types of loans, the lender has no interest in the vehicle and cannot repossess it.
Generally speaking, unsecured car loans are much more difficult to be approved for than loans that use the vehicle as collateral, such as secured car loans. Lenders that have some collateral for a car loan are much more likely to make loans available to a broader spectrum of borrowers and not be quite as strict with credit and lending requirements.
On the other hand, lenders that make personal or signature loans for people to make unsecured car purchases with, will usually require that borrowers have overall good or excellent credit scores and display an above average ability to repay the loan. Lenders that make unsecured car loans will require higher borrower incomes, lower debt to income ratios and good overall financial stability of the person applying for the loan.
Because there can be more risk for the lender when making unsecured auto loans, banks or finance companies that make these types of loans will usually charge higher interest rates. A higher interest rate is the only incentive the lenders have for making these types of loans. There is no collateral, thus nothing to repossess, in the event the borrower defaults on the loan.
Dealing With Defaults
If you don't make your payments with a secured auto loan, the lender repossesses the vehicle. With an unsecured loan, there is no collateral to repossess. However, that does not mean the lender does not have recourse. Lenders that make unsecured auto loans are much more likely to sue you in civil court for a failure to live up to your end of the bargain and make payments on an unsecured loan. If they win - and they probably will - they may then be able to place a lien on your vehicle and take it anyway.