Understanding the Difference Between Secured and Unsecured Auto 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 while. 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 it. If you are unwilling to return the vehicle, it will be repossessed. In the United States, unsecured car loans are generally not termed as such and are actually personal or signature loans made to a borrower where the proceeds are then used to purchase a vehicle.
When a consumer applies for and is approved for a signature loan, the borrower can then use these funds for almost any purchase they choose. In this instance, the funds are used to purchase an automobile. 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.
A benefit of an unsecured auto loan is the fact that as soon as you use one to purchase the vehicle, the automobile is yours. There will be no lien holder, so you will be free to choose the type of insurance coverage you want to maintain on the vehicle as well. With a secured auto loan, you will always be required to maintain full coverage insurance on the vehicle until it is paid off. Also, since there is no lien holder on it, the vehicle cannot be repossessed the way one can when purchased with a secured car loan.
Generally speaking, unsecured car loans are much more difficult attain than 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.
Most banks and finance companies that provide these kinds of loans usually require higher credit scores, better debt-to-income ratios and better overall financial soundness than they would for loans secured with an automobile. Thus, you probably won't qualify for a sizeable unsecured auto loan if you have poor or marginal credit.
Because there is 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, as this helps to protect the their profits. No collateral means more risk for the lender.
Before you purchase a vehicle with an unsecured loan, remember that a traditional auto loan is your best choice when getting a new or pre-owned vehicle. An unsecured loan will be for a small amount, and you may not be able to get the vehicle you want. If necessary, use the unsecured loan as a down payment on a traditional auto loan. Although many lenders do not allow borrowed down payments, some will proceed with the loan.